Is hhgregg, Inc. the Next Best Buy?

This article is part of our Rising Star Portfolios Series.

Specialty retail is a fickle beast. Knowing what is hot and what's not can make or break a company's position. And if the customer's not getting both a superior experience and the best deals in town, they'll bolt faster than you can say Circuit City -- just ask Circuit City.

Best Buy (NYSE: BBY) has certainly reaped some of the rewards of Circuit City's demise. However hhgregg, Inc.  (NYSE: HGG) has been around for 55 years, and is starting to make an impact in the market. But which one is the better investment? By taking a look at a few different ratios, we can get an idea as to which company may have better days ahead.

It's cyclical
The cash conversion cycle is one of the best measures of how a company is managing its working capital. It represents the number of days it takes a company to convert raw materials into goods or services, finished goods into sales, and sales into cash -- or more simply put, how long it takes to get cash spent on raw materials back via sales. With this in mind, the lower the number the better; here's how hhgregg and Best Buy convert:

Source: Capital IQ, a division of Standard & Poor's.

Not terribly surprising here given Best Buy's scale over competitors. But it will be interesting to see how hhgregg's conversion cycle trends over the coming years as it continues to grow.

Inside the margins
Operating margin, also known as the EBIT margin (earnings before interest and taxes), is an excellent indicator of operational efficiency. These are the earnings that take into account the company's operating expenses and this can tell us how much the company is spending to operate the business -- earning $1 million doesn't mean much if it costs $950,000 to do it. So how do these two compare? Here are the figures:

Source: Capital IQ, a division of Standard & Poor's.

Not much disparity here over the last five years. Where scale helps Best Buy stay efficient, hhgregg also focuses on efficiency and selling higher margin items in the process.

I love turnovers!
Inventory turnover is another valuable metric, particularly in retail. It can tell us how often a company's inventory is sold and replaced over a given period of time. Comparing inventory turnover ratios in the same industry can offer some insight as to which company may be performing better: the higher the number, the better the performance. Here's how they turn over inventory:

Source: Capital IQ, a division of Standard & Poor's.

Wow, dead-even over the last five years. Both companies are doing an effective job of keeping inventory moving. That compares to Wal-Mart's (NYSE: WMT) average of 8.4, which is about as efficient an operator as you're likely to find. So the performance of these guys is pretty good.

So what does all of this mean?
All things being equal, when we consider these three metrics in assessing both businesses, Best Buy has a slight edge over hhgregg in the cash conversion cycle. But these aren't the only metrics to consider when assessing a business. hhgregg is in a much different position than Best Buy: its $865 million market cap is minute compared to Best Buy at almost $14 billion, but I'm pretty sure we can expect some significant growth from hhgregg in the coming years.

Both hhgregg and Best Buy are quality businesses, and I'll continue to seek out other winning investments for my Motley portfolio keeping these very same ideas in mind. Wanna talk shop? Swing on by my discussion board, and you can also follow me on Twitter.

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