SUPERVALU Is a Lesson in Overvalued Retail Stocks

Foolish investors should not roll with retail companies whose share prices have been rocked by traders' hopes that these businesses conceal undervalued assets. Too many times in the past, financial professionals have made claims about retailers' assets that just didn't match up to reality.

Sears at $200 a share is cheap based on assets
Billionaire hedge manager and major shareholder Bruce Berkowitz claims that Sears Holding (SHLDQ) has a value of $160 a share based on its real estate holdings. He further said, in a recent interview, that the inventory was worth close to another $60 a share . While Berkowitz sees Sears as worth over $200 a share based on its assets (real estate and inventory), the current share price is around $40.00. There are many other companies in some segment of the retail sector trading at substantial discounts to the asset values, according to financial analysts.

What happened to $11 a share for SuperValu?
SuperValu (SVU) is another example of a beaten-down stock whose assets were touted by a Wall Street professional as being worth more than the market says it's worth. In an interview last May, a JP Morgan (JPM 0.49%) analyst stated that SuperValu, a grocery store chain, had an asset value of $11 a share.  At present, SuperValu is trading around $3.35, up from its low for the past 52-weeks of $1.68. The stock jumped recently, because SuperValu struck a deal with Cerebus, an investment group, to sell its Acme, Albertsons, Jewel-Osco, and Shaw's stores for $3.3 billion. If, for some reason, the sale does not go through, the share price of SuperValu will likely plunge.

Look Beyond the Ratios
Although it is impossible to know exactly which ratios Berkowitz and other finance professionals base their decisions on, as that is closely guarded, investors should be wary of things that appear "too good to be true." For retail companies with low share prices, these could be the price-to-sales ratio or the price-to-book ratio.

The price-to-sales ratio measures the sales compared to the stock price. The price-to-book ratio gauges the asset value against the stock price. These ratios can result when a company in retail, such as SuperValu, Sears, JC Penny (JCPN.Q), Best Buy (BBY -0.81%), or Rite Aide (RAD 24.00%) fall in share price.

What seems to be an indicator that the stock is undervalued may not be what it seems. A low price-to-sales ratio and a low price-to-book ratio can mask that the inventory is not selling. As the stock price falls due to declining sales growth, the inventory and real estate remains on the books at a high value, despite customers not buying the retailer's goods and services. That can distort both the price-to-sales ratio and the price-to-book ratio for a retail business.

The table below compares the price-to-sales ratio and the price-to-book ratio of Wal-Mart (WMT 1.32%), the biggest retailer in the world and a major competitor of SuperValu, Rite Aide, JC Penny, Best Buy, and Sears. The price-to-sales and price-to-book ratio for Wal-Mart appear overvalued compared to the others. But the stock price for Wal-Mart has performed much better.

Source: The Motley Fools CAPs and Finviz; *Sears soared in early 2012 on buyout rumors . It is down 30.56% for the last six months.

Wal-Mart's superior cash conversion cycle is a huge competitive advantage. The cash conversion cycle measures how promptly a business processes its inventory as it charts how long it takes to pay for a product, sell it, and then deposit the proceeds in the bank. The shorter, the better. As the chart below shows, Wal-Mart is far better than Sears, Best Buy, and JC Penney, because its inventory sells quicker, rather than sitting on the shelves.

WMT Cash Conversion Cycle data by YCharts

A Fool Shops for Bargains
Foolish investors have an advantage over Wall Street analysts in the retail sector. Investing legend Peter Lynch advised individuals to visit the malls and see what products were selling in which stores. Should the parking lots be filled with lines of shoppers out the door at SuperValu, Sears, JC Penney, and Rite Aid, then investors should buy to profit from the turnaround that could be coming. Along with the bustling crowds at the checkout line, the cash conversion cycle reveals that the goods and services are indeed selling.