Why Ross Stores and TJX Companies are Cheaper Than Kohl's

 

Ross Stores (NASDAQ: ROST  ) and TJX Companies  (NYSE: TJX  ) , both look more expensive than fellow retailer, Kohl's (NYSE: KSS  ) at first glance, but they're not. Understanding why this is true will not only lead you to two stock picks, it may also make you a better value investor. 

Let me explain.   

Go Beyond Traditional Valuation Tools
Ross Stores and TJX Companies have higher P/E's, of 17 and 19 respectively, than Kohl's, at 13. So how are they cheaper? The simple answer is that a low price (or multiple) only explains what you are paying. Price is what you pay, value is what you get. 

 Every investor has bought a stock because it seems "so cheap," only to watch it get cheaper, and cheaper. Moving your focus away from price can help you avoid that trap.

I first started looking outside traditional valuation tools (P/E, book value, etc.) when I was introduced to Joel Greenblatt's "magic formula" investing approach. This is a great way for newer investors to understand, in simple terms, why the quality of a business matters in valuation. 

This approach looks for stocks with the best combination of a low earnings yield and a high return on capital. Top rated magic formula stocks may not have the lowest earnings yield (or "P/E") but they have a relatively low one, when you consider their returns on capital. 

So while Ross Stores and TJX may not seem as cheap as Kohl's on a price-to earnings basis, their returns on capital are about 30% higher! In addition, as the chart below shows, this advantage has been enjoyed for years and now it is actually expanding. 

TJX Return on Invested Capital (TTM) Chart

TJX Return on Invested Capital (TTM) data by YCharts

You simply shouldn't perform valuations on an absolute basis; value is always relative to the underlying business. Both Ross and TJX have returns of capital of 40%, that means, for every dollar invested in the business, forty cents will be earned on an annual basis. That is simply phenomenal. To add additional perspective, for every dollar you invest in Kohl's, you get just ten cents. Since you get more with Ross Stores and TJX, they're worth more. Plain and simple. 

When you consider the returns on capital, they are trading at a drastically cheaper valuation than Kohl's. 

Consider growth
While the investing world  may want to separate all investing philosophies into a "growth" or "value" camp, they actually both feed off of each other. Some of the best investors of all-time, like Peter Lynch, made a killing by using growth as part of a (relative) stock valuation. 

Ross Stores most recent quarterly results showed a 7% increase in earnings, year over year, and a 6% jump in sales. TJX Companies sales rose 5% in its latest showing, and net income barely budged at all. These results may not seem stellar, but they easily best Kohl's and most traditional retail department stores. 

Just look at these figures (below) of net income per employee; Kohl's is the clear laggard. This statistic measures net income growth relative to retailers largest overhead expense (employees). Stats like these are increasingly important for traditional retailers due to e-commerce competition; Kohl's is trending poorly. 

TJX Net Income Per Employee (Annual) Chart

TJX Net Income Per Employee (Annual) data by YCharts

And now, Ross and TJX are growing sales faster than Kohl's as well (below). 

TJX Revenue (Quarterly YoY Growth) Chart

TJX Revenue (Quarterly YoY Growth) data by YCharts

ROST Revenue (Annual YoY Growth) data by YCharts


There's no reason that this trend shouldn't continue. Ross, TJX, and Kohl's compete for similar customers, folks who want something now and who want it cheap. The difference is that Ross and TJX are "off-priced" retailers, they will always give you an advantage on price (and name brands), your shirt just may not be from this season. 

Kohl's meanwhile is one of a few department store retailers I feel is really in a "no-man's land," it's not high-end, but it's not cheap, so what is it? For example, if you want to buy a men's polo-shirt from Kohl's, you'll find brands like "Mark Anthony" and "Wolverine," you don't really have a chance at scoring a deal on a high-end brand. That's a scary mix of poor selection, at poor prices, and I don't know if it is sustainable in tomorrow's retail environment. 

3D Valuation
Whether you're using Joel Greenblatt's "magic formula" or using Peter Lynch's philosophy of considering growth as part of your valuation, the idea is the same. Valuing a stock simply on a price-to-earnings, or price-to-book, basis is the equivalent of looking at a 2D image. You're getting one side of the argument--how cheap the stock is today.

We all know that the stock market looks to the future. In the example used, we see that Ross Stores and TJX are earning higher returns on capital, and growing faster, than Kohl's. That's not an aberration. They both have more to offer customers, and the numbers show that. So, if you buy a 2D stock today, you may not see that its business is in decline, and it may get a lot more "expensive" tomorrow. 

I recommend you consider the quality of the business you're buying as part of your valuation. With that in mind, I think Ross Stores and TJX Companies look pretty cheap right now. 

Warren Buffett just bought nearly 9 million shares of this company
Imagine a company that rents a very specific and valuable piece of machinery for $41,000 per hour (That's almost as much as the average American makes in a year!). And Warren Buffett is so confident in this company's can't-live-without-it business model, he just loaded up on 8.8 million shares. An exclusive, brand-new Motley Fool report details this company that already has over 50% market share. Just click HERE to discover more about this industry-leading stock... and join Buffett in his quest for a veritable landslide of profits!


Read/Post Comments (0) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2986223, ~/Articles/ArticleHandler.aspx, 10/25/2014 4:01:10 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement