With consumer confidence waning, and red flags replacing green shoots all across the economic landscape, consumer discretionary companies are looking increasingly risky. Even so, shares of leading U.S. consumer electronics retailer Best Buy
Yellow and blue don't always make green
Many investors might argue that the recession dulled Best Buy's bright yellow-and-blue color scheme. Their generally gloomy view shrouds the retailer's stock, which has sunk roughly 14% year to date, and plummeted 30% from its April high.
However, there's an upshot to this dour outlook. Best Buy's price-to-earnings multiple now stands at 10 times this fiscal year's consensus estimate -- well below the market's 2010 P/E of more than 16, and an even greater discount to the company's historical valuation from any year between 2003 and 2007.
Of course, what appears cheap can become cheaper, and the company's latest quarterly report sparks its fair share of doubts. First-quarter earnings per share rose an anemic 1.3%, on a 7% increase in revenue and a nearly 3% gain in same-store sales. Management expressed disappointment in the bottom-line performance, citing higher-than-expected investment expenses and "episodic" consumer purchasing behavior. Plus, Best Buy's domestic segment was hit by price declines on TVs, and suffered lower same-store sales in the gaming, music, and movies categories.
On the other hand...
Yet there is legitimate cause for optimism as well. Independent reports from earlier in the year indicated that Best Buy was aggressively gaining market share following the demise of competitor Circuit City, and outpacing Wal-Mart
In addition, following several years of planning, the company appears close to a full-scale rollout of its much-talked-about used-video-game initiative, which will allow customers to both trade in and purchase used titles. That's obviously bad news for ailing competitor GameStop
Finally, while Best Buy's five-year compound annual sales growth of 12.4% pales in comparison to the nearly 30% rate posted by online retailer Amazon.com
Is Best Buy a best buy, a weak buy, or what? First, let me say that I'm extremely cautious about the U.S. consumer. I expect that the "episodic" nature of consumer spending Best Buy management mentioned will persist, if not deepen. To see what cyclical, unpredictable business results and declining product margins can do to a stock's P/E, look to disk-drive makers Seagate Technology
Now, I don't foresee Best Buy suffering a similar fate, but I do believe that the stock will continue to trade at or below the broad market's multiple. And if the economy tanks again, we could well see the S&P 500 trading in a P/E range of 6-8, a la the early 1980s.
Ultimately, for long-term investors looking to initiate a position, this is probably a good (but not great) time to start picking up shares. However, for those who already have a large stake, I wouldn't add until a P/E of eight or lower pops up on your screen. Then, wheel out the shopping cart.