Ross Stores (NASDAQ:ROST) is a retailer that doesn't grab a lot of headlines, but long-term investors in the company have certainly been treated well overall. Since the company released its third-quarter earnings report this morning, let's give this somewhat overlooked company a bit of attention.
The bright spot for Ross is that sales were up 20% for the quarter. Unfortunately, cost of goods sold was also up 21%, because of adjustments to inventories and accounts payable. Operating expenses increased, as well, bringing net earnings for the quarter down by 3.7%.
But there is some light at the end of the tunnel. Earnings per share were flat with a year ago because of share repurchases by the company in the past year.
The share repurchases are good news that should keep on giving, as the company announced that its board of directors authorized the repurchase of up to an additional $400 million of its own shares in the next two years. If fully executed, that would represent a little bit more than 10% of the company's outstanding shares as of today. To further reward shareholders, Ross bumped its dividend up by 20% from $0.05 per share to $0.06 per share. That's a sizable increase, but at $25 per share, the yield is still unimpressive at less than 1%.
It looks like the company's dividend will cost it approximately $29 million this year and, with the 20% increase, approximately $35 million next year. Plug that $35 million payment into the company's average of $162.7 million in free cash flow over the last three years, and you have a well-funded dividend with room for further increases. In some ways, this begs the question of why the dividend wasn't raised further at the expense of a smaller share repurchase.
I think it's mainly about providing a balance. Share repurchases, when executed at prices below the company's value, are a great way to return value to shareholders in bursts while avoiding the tax man (for those shareholders not selling shares back to the company). Dividends, on the other hand, are considered more permanent by investors and need to be well funded by free cash flow. Raise the dividend too far too fast, and you take away the flexibility that share repurchases can provide.
As unimpressive as Ross Stores' quarter was (its shares are down 4.5% today), it's not fair to judge a company based on one quarter's financial results. After all, this is a company that has rewarded shareholders with significant gains not only since 2000, but since going public, and it doesn't look like there's any structural reason to believe that the company can't continue doing so.
On the other hand, I find Ross Stores to be a bit expensive at 20.5 times earnings. In the world of off-price apparel and home product retailers, investors have Ross, TJX Companies (NYSE:TJX), Stein Mart (NASDAQ:SMRT), Burlington Coat Factory (NYSE:BCF), and Tuesday Morning (NASDAQ:TUES) as primary options. Each has its own unique way of approaching the off-price market, but given the current valuations, TJX looks the most attractive to me because of its underlying free cash flow potential. Second best in my view is Tuesday Morning because of its historically excellent return on invested capital. And both of those companies can be had at multiples that are below Ross'.
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Nathan Parmelee has no financial stake in any of the companies mentioned. The Motley Fool has an ironclad disclosure policy.
