I'm a big fan of shareholder letters. Reading just a few from any company can tell you a lot about the company's management and how well they treat their shareholders. Warren Buffett's letters to shareholders are the gold standard, and having re-read some of the letters done by KimcoRealty (NYSE:KIM) this week, I believe the REIT does an excellent job in this regard as well.
I'm also impressed with the letter to shareholders that Sears Holdings (NASDAQ:SHLD) Chairman Edward Lampert provided, and I'm even more impressed that the company posted it on its website. It's full of information specifically for Sears shareholders, but there are lessons in it that are applicable to all investors. The portion I found the most fascinating was the discussion on same-store sales.
I've stated before that I think the focus on same-store sales is overblown. Abercrombie & Fitch (NYSE:ANF) and Starbucks (NASDAQ:SBUX) routinely report strong same-store sales results, and it's an important metric, but it's not the only lever available to a company. And it's certainly not the metric I consider the most important for either company. That's an important point that people seem to lose sight of when same-store-sales (SSS) numbers are released, especially for a company that operates profitably and has a high return on invested capital. The Sears letter to shareholders says pretty much the same thing, as the following excerpt demonstrates:
If we take a simple example of a single store, then a comparison of SSS from year to year is fairly straightforward. If a store does $1 million in sales at a 10% operating margin this year, generating $100,000 in operating profit, and does $1.1 million in sales next year at the same operating margin of 10% generating $110,000 in operating profit, it will report a 10% increase in SSS. Now, let's add another dimension. Imagine that this same store spent $500,000 to improve the store experience during that year. The 10% increase in SSS generated an additional $10,000 in profit. Whether the $500,000 investment makes sense or not in hindsight will depend on the future performance of the store. Obviously, if the store only improves by the $10,000 in profit, the $500,000 investment doesn't make sense. I believe that companies that pursue SSS growth at any cost often fall victim to these traps.
I'm not sure how the Sears Holdings story will unfold and whether the company will ultimately be able to become a force in retail again. It's honestly not a story I've followed all that closely. However, the letter offers plenty of lessons for investors -- including an interesting discussion on pensions, liabilities, and share repurchases -- on how to think about companies and how they operate. And investors should give it a read for that reason even if they have no interest in the company.
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Nathan Parmelee owns shares in Starbucks but has no financial interest in any of the other companies mentioned. The Motley Fool has an ironclad disclosure policy.
