Workshop Portfolio


Margins - Old Friends      

by Louis Corrigan (TMF Seymor)

Atlanta, GA (April 6, 1999) -- Not a lot to choose from on our Rising Margins screen this week -- but enough, including several old friends.

First up, Workshop favorite Best Buy (NYSE: BBY), the consumer electronics retailing giant that's been one of the best performing stocks over the last few years. It's increasingly seen as a play on everything digital (DVDs etc.). In reviewing the company's awesome Q3 results on December 22, I concluded that "Best Buy still looks great, even though the stock has paused for results to catch up with earlier gains. The margins theorem says keep holding if you own these shares."

Since then, Best Buy has leaped nearly 80% higher, to around $52 a share, reinforcing one of the prime lessons this screen has to teach you: Businesses on a roll often stay on a roll. Rising margins indicate that a firm's business is becoming more profitable. That means a whole lotta something is going right in a world where many things can go wrong. In those situations, you will usually be rewarded for patience. If you still like the story, keep reading (that is, be an owner, not a trader), even if you have doubts about the stock's valuation. The market could be telling you that the business will catch up to the stock.

Best Buy's Q4 sales increased 21% to $3.5 billion, with same-store sales up a terrific 10.8% on top of a 16.9% gain in the year-ago period. That pumped up EPS to $0.52, two cents ahead of estimates and 63% above the year-ago period. For the year, sales jumped 21% to $10.1 billion on a 13.5% gain in comp store sales versus 2% in 1997.

Although selling, general and administrative (SG&A) expenses increased to 12.9% of revenue from 12.2% in Q4 1997, the increase resulted from higher bonuses for a job well done. The Q4 gross profit margin improved to 17.9% from 16% due to a more profitable sales mix, faster inventory turns, and continued growth in the sale of very high margin warranties. Despite the sales growth, inventories actually declined in real dollars to $1.05 billion, an impressive feat.

The rest of the story remains pretty much intact, with debt down a lot (to $30.5 million) and cash up a lot (to $786 million) in the last year. The only cause for some concern? Receivables increased 38%, to $132.4 million. You like to see receivables rising in line with or less than sales.

Best Buy now trades for about 49 times trailing earnings and 39 times the current high-side FY2000 estimates of $1.35 per share. That's rich. Backing out its cash, it also sports an enterprise value-to-sales ratio of around 1, also rich for a company with just 2.2% net margins. Still, the Fool Snapshot reveals a solid company that's delivered a 25% return on equity. Once again, the margins theorem would say hold on to this stock.

Some analysts have talked about a $60 price target, and that's certainly not crazy in the current market environment. Longer term, though, I wonder how much the Internet may cut into Best Buy's business and when the market might begin factoring that in. Shorter term, Best Buy plans to open 45 new stores and remodel or relocate 20 others this year. It currently operates 311 stores, so that's significant expansion.

Another retailing powerhouse, Bed Bath & Beyond (Nasdaq: BBBY), the nation's third largest home furnishings company, also makes our screen. Q4 sales increased 37.4% to $419 million, with same-store sales rising 10.8%. EPS jumped 41% to $0.24 from $0.17 a year ago. For the full year, sales shot up 31% to $1.4 billion on a 7.6% gain in comp-store sales. EPS leaped ahead 33% to $0.68 from $0.51.

Meanwhile, inventories increased just 33% and cash rose to $90.4 million from $53.3 million. Plus, the company has no long-term debt. Checking the Fool Snapshot, we see a robust performer with a 27.5% return on equity. Moreover, Bed Bath & Beyond operated 186 stores at year end but plans to add another 50 this year, so it's looking to get much bigger, and fast.

Still, at $37, the stock trades for 54 times trailing earnings and 43 times even the high-side earnings estimate of $0.87 for this year. That's rich enough to help explain why family trusts of Warren Eisenberg and Leonard Feinstein, the company's co-chief executive officers, have filed to sell 2 million shares. Though these trusts reportedly still own a combined 12% stake in the company (over 17 million shares), the announcement sent a little shiver through the stock on Monday.

It's also worth noting that the firm barely made our margins threshold. Due to a dip in gross margins, operating profits actually declined to 13.2% of sales from 13.3%. Only a doubling of interest income from its cash made up for this shortfall. On an operating basis, then, margins declined. This is one of those toss-ups. The margins theorem allows us some leeway with such situations, suggesting Bed Bath & Beyond is worth holding on to. And the solid balance sheet leaves me inclined to second that motion.

However, the kind of strong same-store sales figures the company has recorded ought to translate into better margins. With the likes of Pier 1 (NYSE: PIR) getting slaughtered by a turn toward negative comps despite the strong housing market and booming economy, investors might want to look more closely at threats on the horizon for Bed, Bath & Beyond. Given its premium valuation, this stock could get hit hard with any disappointment.

Next, DMI Furniture (Nasdaq: DMIF), a residential and office furniture maker that made a phantom appearance on our screen in January (EPS margins soared thanks to a 29% dip in diluted shares outstanding due to a retirement of preferred stock in August). Now, after losing over 30% of its value since we last looked at it, DMI makes our screen honestly.

Q2 sales took flight, rising 58% to $12.7 million, thanks to a 170% surge in sales of small office/home office furniture and shipments by its new Wynwood division. Substantially increased sales to an unnamed major customer (Sam's Club?) accounted for a goodly part of the gain, which quadrupled EPS to $0.08 from $0.02 a year ago. To double-check that the margin increase is legit, we see from the press release that operating margins rose to 5.1% from 3.1% a year ago.

With one analyst projecting DMI to earn $0.63 per share for the year ending in August and the stock now at just $3 3/16, is the stock now a bargain at a forward P/E of just 5? Well, the Fool Snapshot reveals DMI to be weighed down with debt and, due to its highly competitive business, sporting some fairly ugly performance numbers. Turning to the actual 10-Q filing, we see long-term debt of $22.5 million and a book value of $11.86 million, still below the current $14.2 million market cap.

The discussion section also notes, "Although the Company expects that sales growth for comparable periods in the future is possible, the magnitude of any sales increases for comparable periods in the future will likely be less than the increases being reported for the three and six month periods in this report."

That might be just a typical boilerplate disclaimer for DMI, but I doubt it given the general weakness in the commercial office furniture market. While I like boring businesses, the debt scares me here given the generally tough environment for office furniture companies. Though it might be worth checking out the rising sales to the "major customer" (will they continue?), this micro-cap is probably too small and risky to merit any further research.

Another old friend, drug store chain Walgreen (NYSE: WAG), delivered yet another strong quarter. EPS shot up 17.6% to $0.20 from $0.17 as sales climbed 14.6% to $4.7 billion on 9.4% improvement in same-store sales. At $27, it's unchanged since last we checked in (after adjusting for a 2-for-1 split). Walgreen trades at 45 times the consensus earnings estimate of $0.60 for the year ending in August, a rich multiple for a stock with prospects for 16% long-term growth.

Still, Walgreen is a premier drug store chain that's held up well despite the specter of price competition raised by's (Nasdaq: AMZN) entry into the mail order drug business and troubles at competitors such as Rite Aid (NYSE: RAD).

Finally, National Discount Brokers (Nasdaq: NDB), a top-ten online broker that's nearly doubled since appearing on the Rising Margins screen in early January. Q3 earnings roared ahead 314% to $0.58 per share from $0.14 last year as revenue came in at $68.2 million, up 81%. Results benefited from a surge in trading volume. For more, check out the recent Daily Double.

New Rankings | Workshop Returns

Workshop Portfolio

9/28/01 as of ~5:30:00 PM EDT

Ticker Company Price
Daily Price
% Change
AETAETNA INC NEW0.943.36%28.94
BABOEING CO(1.04)(3.02%)33.36
COGCABOT OIL & GAS 'A'0.693.59%19.90
DDDU PONT (EI) DE NEMOURS0.992.74%37.14
DGXQUEST DIAGNOSTICS(0.45)(0.73%)61.42
EKEASTMAN KODAK0.421.31%32.49
GMGENERAL MOTORS1.393.38%42.55
MOPHILIP MORRIS COS(0.76)(1.55%)48.24
NEWPNEWPORT CORP0.261.90%13.97
NVRNVR INC(0.54)(0.38%)140.41
QCOMQUALCOMM INC(0.40)(0.84%)47.16
SLESARA LEE CORPUnchg.Unchg.21.09
WMIWASTE MANAGEMENT(0.01)(0.04%)26.74

Overall Return -- total % Gained (Lost)
  Day Week Month Year
To Date
Comparable S&P 500n/an/an/an/a(19.07%)
S&P 500 (DA)1.95%7.48%(8.33%)(21.22%)(14.88%)
DJIA (DA)1.68%7.07%(11.07%)(17.86%)(2.22%)

Internal Rate of Return -- Annualized Rate of % Gained (Lost)
  Since Inception (12/24/1998)
vs. S&P 500(17.63%)

Trade Date # Shares Ticker Cost/Share Price Total % Ret

Trade Date # Shares Ticker Total Cost Current Value Total Gain

• S&P 500 (DA) = dividend adjusted. Dividends have been added to the total return of the index.
• DJIA (DA) = dividend adjusted. Dividends have been added to the total return of the DJIA.

Note: The Workshop Portfolio was launched on December 24, 1998, with $4,000 which was invested in the Foolish Four strategy. Approximately $15,000 was added on January 8, 2001, to support five additional mechanical strategies. At that time approximately $1000 was transfered out of the Foolish Four strategy to bring the Foolish Four into balance with the other strategies. (That's why the Foolish Four's overall return is not consistent with stock values.) Such rebalancing will take place each year among the strategies so that each will start out with approximately the same value at the begining of the year. No more cash additions are planned. The first four tables above show the overall performance of the portfolio. Below that we also track the performance of each component strategy. All transactions are announced publicly before being made, and returns are compared daily to the S&P 500 and the Dow. (Dividends are included in the yearly, historic and annualized returns.) Stocks are chosen using strategies developed by the Workshop community.