After Reaching Multi-Year Highs, Is This Retailer Still a Good Buy?

On Tuesday, shares of Best Buy (NYSE: BBY  ) surpassed $40 for the first time since 2010, after Cleveland Research noted "encouraging " sales trends for the third quarter. While comparable sales growth of 1%-2% apparently has investors excited, at some point valuation must be considered. With that said, is Best Buy still a good buying opportunity?

An ever-changing model
As investors, it's important to realize that the value of a company's stock is nothing more than a reflection of current and future earnings expectations. Sometimes we make investing more difficult than it should be, but perhaps a good way to determine fair value is to compare a company's fundamentals to years prior when priced the same.

 

2010

Last 12 Months 

Revenue

$49.74 billion

$48.15 billion

Net Income

$1.27 billion

($350 million)

Operating Margin

4.7%

2.17%

Debt to Assets Ratio

9.5%

12.6%

Operating Cash Flow

$1.19 billion

$1.83 billion

Best Buy clearly has areas of strengths and weakness relative to 2010. Its revenue has declined slightly and its margins are lower, but its operating cash flow is higher. There have been many changes to the nature of Best Buy's business, however, and this has consequently led to the differences in the two years.

For one, Best Buy's competitor Amazon (NASDAQ: AMZN  ) has added more than $30 billion in annual revenue between 2010 and the last 12 months . Amazon has essentially doubled in size. During that same period, Amazon's net income has gone from $1.15 billion to negative $100 million as the company implements goods with breakeven pricing.

This fact has affected Best Buy, a company that has been forced to lower costs and offer price matching with the likes of Amazon. In many ways this gives Amazon an unfair advantage, as Best Buy has more square footage that it has to heat, pay taxes on, and keep the lights on in. This all makes it harder for Best Buy to match such low prices.

With that said, Best Buy may lag with pricing – as it relates to margins – but it has gained with the addition of online sales tax. Earlier this year, the U.S. Senate voted 75-24 in favor of a non-binding resolution that backs online sales tax, as e-commerce now accounts for more than 5% of all retail . Best Buy has gained with this new legislation, as its online sales have posted double-digit growth in each quarter this year.

 In addition, this bill may reverse a trend where an estimated 20% of all consumers who purchase electronics at Amazon first test the products in-store. Best Buy's price matching along with online sales tax have likely helped to reverse this trend, and has Best Buy expecting long-term growth.

Which is better now?
Clearly, much has occurred over the last couple years. Does this mean that Best Buy is in fact a "buy" now? To answer that question, comparing the company to another that sells similar products and also offers price matching might be beneficial in understanding how the market is valuing such companies, based on future expectations. To do this, we turn to Staples (NASDAQ: SPLS  ) .

Staples is very much like Best Buy, selling office products and consumer electronics. When we compare the two companies side-by-side, we see that they are in fact very similar. Staples trades at 11.4 times next year's earnings with a price/sales multiple of 0.42. Best Buy trades at 15 times its forward earnings and 0.28 times sales.

Because of this, these two companies are valued in a similar manner. One striking difference is that Staples is seeing a greater degree of fundamental declines. During its last quarter, Staples saw a 2% revenue decline, but more importantly, a near 15% loss in net income . As a result, margins declined.

Moreover, Staples has operating margins of 6.1 %, but now with price matching it's tough to imagine a scenario where those margins are sustainable since similar companies are barely breaking even. It appears that Best Buy is better valued for the reality of a price-matching retail environment.

Final thoughts
For consumers, it is awesome that Amazon has grown in size and changed the pricing landscape in retail. After returning gains of 250% in 2013, however, the question is whether or not Best Buy is still a good investment in this new environment that is significantly different versus 2010.

To me, a Best Buy that is less leveraged with debt, has higher margins, and is profitable has greater upside when priced at the exact same point. In many ways, this is exactly what we have encountered as we compare 2010 to the last 12 months.

With that said, online retail sales and Best Buy's decision to actually rent its square footage to the likes of Apple, Samsung, and Google shows a willingness to innovate and make change in an evolving retail environment. With a market cap of nearly $14 billion, however, Best Buy might be too expensive to bet on the fact that these changes will pay long-term dividends to investors.

Therefore, understanding the premium on shares of the company and proceeding with extreme caution is well advised. Sure, Best Buy has reached multi-year highs, but investors must realize that this is not the same company as in years past. Hopefully, new initiatives will spark growth for the company. Until that growth is realized, though, Best Buy looks to be risky right now.

 

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  • Report this Comment On October 21, 2013, at 11:59 AM, smadi2012 wrote:

    you can bit your house on this one, it will be $100 soon, I'm kidding.

    I'm not sure how much more air can be blown into this one.

    At these levels, It feels like it is going to be popped at anytime.

  • Report this Comment On October 21, 2013, at 5:37 PM, mistacy wrote:

    BUBBLE POPPPPPPPPPPPPPPPP.

  • Report this Comment On October 21, 2013, at 9:25 PM, lenholliday wrote:

    Yes, Best Buy (BBY) Stock is a good Buy! Good Buy Car, Good Buy college education, Good Buy new house, Good Buy Mother-In-Law! It is a good buy alright! Best Buy (BBY) stock at $41 per share is over valued by about $31 per share. If it traded for $10 per share I would tell you it is fully valued! I would risk JCP, J.C. Penny on a turn-around play before I would pay $41 per share for BBY. You would have to be out of your mind to pay north of $40 per share for this old-run-down with no hope big-box chain with no fresh ideas and a management team that has not had an original idea in 10 years. In other words, I would rate Best Buy (BBY) as a DOG-STOCK!! Short It at the market all day long with a 36-month Target Of ZERO($0.00). Out Of Here. Gone! Good Night Irene!

  • Report this Comment On October 22, 2013, at 8:32 PM, sicownsin wrote:

    I just LOL when I read this... Let's see from the Fool archives.

    Don't buy Best Buy when they were selling at $12, $15, $20, $25, $30, $35, $40, now $42 it's too "risky." I sure am glad I did NOT listen to the advice when I purchased at the $15 range and sold half at $38 mark...

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