Just like there are two sides to every coin, there are always two sides to every investment opportunity. For an investor looking at a company for the first time and with an eye toward possibly investing in it, evaluating the good points alongside the bad points is not a bad way to structure the research process. That's one of the reasons why the weekly Dueling Fools feature on this site is always popular and instructive. With every stock, there are two sides to the story.
Boiling a new company down into its good points and bad points takes some practice, but the exercise is worthwhile. Some good starting points are reviewing the company's recent news, its financial filings such as 10-Q quarterly reports and 10-K annual reports, its proxy statement, and any information that may be available at its corporate website. By spending just a few hours with a company, you can learn a great deal about it and reach some preliminary good points/bad points conclusions. With enough time and practice looking at companies this way, the most interesting aspects of a particular company will more or less "pop out" at you.
As an example of how to do initial company research in this manner, I'll use a small company named Charlotte Russe (Nasdaq: CHIC) that caught my eye recently. The firm is a fast-growing operator of 151 mall-based specialty women's clothing stores in 23 states under the names "Charlotte Russe" and "Rampage." The clothing is aimed at young women ages 15 to 35 who want the latest fashions, but want them at a value price.
Amid a market chock-full of firms with declining share prices, Charlotte Russe has bucked the downtrend and gained a staggering 90% this year. Thanks in part to the rapid share price advance, the company has also shown up on the Foolish 8 one-click scorecard at Quicken.com in recent weeks. However, the firm's days as an undiscovered gem appear to be numbered. That performance has attracted investors like bears to honey, and a number of Wall Street investment firms have picked up research coverage of the firm in the past few weeks.
After spending just a few hours with Charlotte Russe using the research sources listed above, we can reach some preliminary conclusions on the business, or at least come up with a few good points and bad points to research further:
Good Points:
1. High returns business -- The most interesting attribute of Charlotte Russe's business from my perspective is its active inventory management system, which the company calls "test-and-reorder." In short, the company orders small batches of new styles, tests them for customer acceptance, and then places larger orders if customer demand is strong. This means the company's management information system (MIS) is extraordinarily important.
So far, the system has worked very well. Charlotte Russe turns its inventory more frequently than its peers, allowing it to generate strong levels of operating cash flow.
Name and Ticker Inventory Turns*
Charlotte Russe (CHIC) 17.0 Wet Seal (WTSLA) 13.2 bebe stores (BEBE) 6.1 Chico's FAS (CHCS) 5.5 *Inventory turns equals trailing twelve
month Cost of Goods Sold divided by average
twelve month Inventories
2. Expansion possibility -- For any retailer, being able to roll out the concept to more locations is an important consideration. Despite its growth from 35 stores in 1996 to 151 stores today, Charlotte Russe still has many new geographic areas to enter in the future. More than half of its stores are concentrated in the high-population states of California, Florida, New York, and Texas. So, the company still has a decent amount of growing room.
Bad Points:
1. Non-organic growth -- So far, Charlotte Russe's rapid store expansion has been a good idea. The company estimates that its average net investment cost for opening a new store is $450,000, but the typical new store over the past few years has been able to generate $400,000 in store-level operating cash flow in its first year. That's pretty good bang for the buck. It's no surprise, then, to see the company regularly dump a large amount of its operating cash flow into opening and stocking new stores.
The worrisome part, however, is how the stores perform after their bang-up first year. As many retailing concept flameouts from years gone by have found out, rapid store expansion can only drive a firm's top-line growth for so long. Charlotte Russe is still a rather small concept, but at some point it will need same-store sales growth from its existing stores to pick up the slack and keep its cash flow growth alive.
Same-Store Sales Growth
(last six fiscal quarters) Q101 Q400 Q300 Q200 Q100 Q499 3.7% 1.5% 0.6% 3.0% 6.4% 6.3%
2. Small float -- The issue of stock float relates to the number of shares available for investors to purchase in relation to the total number of shares outstanding for a particular company. In Charlotte Russe's case, there are not that many shares to go around. The company was acquired in a leveraged buyout (LBO) in 1996 and those LBO investors still hold the majority of the company's outstanding shares. The LBO investor group has reduced its stake through the company's 1999 initial public offering and an additional stock sale earlier this month, but it still holds an estimated 67% stake, according to theDeal.com.
There's nothing wrong with a big investor group per se. But with just a few million shares available to the public, Charlotte Russe's share price can be driven sharply higher or lower on any given day. Investors should take this volatility potential into consideration. Undoubtedly, the float situation has played a role in the rapid share price increase this year.
To sum up, zeroing in on the major pluses and minuses of a company's story is a good way for the small company investor to conduct an initial round of research into a new idea. Ultimately, despite all of the inputs involved in a business' performance, a company's share price performance over time will boil down to just one or two distinct points. The earlier those key points can be identified, the better for the individual investor.
At the time of publishing, Brian Graney did not own shares of Charlotte Russe, or any other women's retailer for that matter. The Motley Fool is investors writing for investors.
