In addition to the rush of snagging that quick-moving five- or 10-bagger, every Foolish investor wants to find that stock they can grow old with, their Coke and Buffett story.
Recently, I've heard people touting Best Buy
I'm not so sure about this view. While both Best Buy and its rival Circuit City
"The way you win the game isn't the price of the TV -- which is about the same for all retailers -- but the experience you give customers once they are in our stores." These comments, made in a recent Fortune magazine article by Best Buy's CEO Brad Anderson, underscore what may increasingly ail the segment. Pop in your eight track and flashback to the '70s. Electronics retailers were suffering from problems similar to car dealerships -- legions of irritated customers were fed up with pushy sales tactics and, worse, erratically rising prices put forth by local and regional players. Companies like Circuit City stepped in, established national operations, and passed the benefits of economies of scale on to consumers in the form of deeply discounted pricing. Back to the new millennium, and we have the CEO of the leading electronics retailer openly admitting that yellow tags are no cause for excitement because gone are the days of pricing power.
From televisions to stereos to DVD players, profit margins are moving closer to extinction. Margins have been squeezed so much that retailers are essentially getting paid to hold electronics equipment. Once a substantial source of revenue, electronics devices are now loss leaders used to upsell the customer on more profitable items like DVDs. Oddly enough, beyond service offerings like Circuit City's Firedog and Best Buy's GeekSquad, DVDs are one of the last profit margin frontiers for retailers. But even that party can't last forever.
We've gone over eroding pricing power. Maybe you're thinking that long term, things are going to get better and the electronics industry is going to come out with scores of new products. But Fool, beware -- these new products shouldn't be expected to magically contribute to improved margins. Unless these retailers can push inventory costs back to suppliers or come up with new value-added service offerings, electronics retailers will continue to look more like grocery stores than sophisticated high-margin operators.
Electronics and Moore's Law
If you can get over diminished pricing power, you still have Moore's Law to contend with. Moore's Law essentially says that the capacity of processors doubles roughly every 18 months, and it means that computer and electronics equipment will change more rapidly and, in many cases, will become increasingly complex. The law has numerous implications for electronics stores, but I'll go over two of them here: the disappearance of some high-margin products, and a steeper learning curve for electronics sales associates.
First, expect DVDs and the respectable margins they carry to increasingly go the way of CDs. For proof of this decline, look no further than Cisco's
The customer experience and knowledgeable service is one of the last distinct features that the electronics retailing industry has to offer over retailers like Amazon.com
So where do you go from here?
By now you probably think I'm ready to strap on a sandwich board and proclaim that prices are falling and technology is coming on too fast -- the end of the world is coming! On the contrary, there's likely some gas left in both Best Buy and Circuit City for differing reasons.
With regards to Best Buy, I like that it trades at a forward P/E of just over 13. But I'm with the bear on the side of the Best Buy argument and think that consistently declining free cash flow and a late jump into China will prove problematic. Even in the case of Circuit City, despite its flaws, the company is flush with cash and relatively debt-free, making it a private equity or activist investing target if it falls much lower.
However, if you're looking longer term (more than five years), instead of trying to pick through the heap of companies in a declining industry, you can pass on opportunities altogether and wait for a no-brainer. I think if you're in the market for a retailer, both Wal-Mart
With all the opportunities out there, investors don't have to worry about declining pricing power and margins and the unsure future that scores of rapidly changing products bring. While the electronics stores segment might do well in the near term, I think there are other industries out there that will produce more shocking longer-term returns.
For more Foolishness:
- Fool on the Street: Circuit City's Big Challenge
- Fool on the Street: Best Employees, Best Buy
- Fool on Call: Best Buy and Apple Team Up
Best Buy and Amazon.com are both Motley Fool Stock Advisor selections. Wal-Mart is an Inside Value recommendation.