No Hurry To Buy If There Is No Growth...

October 10, 2011 4:19 AM


When you look around the US markets, arguably one of the cheapest large-cap stocks out there is Best Buy. Just a quick view of the figures will prove the point. It trades at 7 times forward earnings,5 times forward cash flow, has a rock solid balance sheet and high returns on capital--even at cyclically reduced earnings. The story gets even better when you realize that the company intends to use its cash flow to retire roughly 20% of the company this year through buybacks. Clearly, this is a cheap stock, so why aren’t I buying? Quite plainly, I don’t see what the hurry is.

Ask yourself this, do you see the US economy improving at any point in the near future? I see two possible options, a complete collapse or the more likely scenario where we muddle along for a decade of stagflation. In such an environment, consumer electronics should be one of the sectors that is most exposed to declines in disposable income. The company has already suffered through a few years of mid-single digit negative sales comps. When you take into account the market share growth that Best Buy has had (the deaths of Circuit City, Sharper Image, Tweeter, etc.), you realize that the industry itself must be declining at a high single digit annual rate with the smaller independents bearing the brunt of the collapse. When will this end? I don’t know, but I can’t see how it ends soon.

BBY

Negative comps at a retailer with considerable fixed costs means declining net margins and reduced earnings. This will be offset by a significant reduction in the number of shares outstanding and likely produce moderate annual growth in earnings per share. Here’s the problem, I can’t see why you have to buy Best Buy today. I think that you can likely buy it in a few years at roughly the same share price, but with half as many shares outstanding. At that point, I’m still not sure if you’d be in a hurry to buy it. 

In the end, growth gets valued at a premium. Non-growth companies are boring. They deserve to trade at low multiples. For now, Best Buy trades at a very low multiple. In a no growth world, I think the rest of the market will eventually trade at a similar multiple. What’s the S&P priced at if the whole market is valued at Best Buy’s 7 times earnings? It’s much lower than today’s quote, and that would assume that earnings do not decline with further margin compression or increased tax rates. Let’s just say that with few exceptions, I’m in no hurry to buy most businesses, even though many of them seem cheap.

BBY Chart

Chart Courtesy of BigCharts.com The stock has gone nowhere in a decade...

People continue to ask me why Chipotle Mexican Grill (CMG: NYSE) trades at 34 times forward earnings. In a no growth world, investors cluster into the few companies with true growth. Burritos are a growth business. I’m not saying that it’s not an expensive stock, but in the market, you pay up for growth because growth rewards you. Unfortunately, most businesses are in a no-growth or negative growth phase.

At some point in the next few years, the US will come out of its current recession. Best Buy will have cut costs to the bone and have significantly reduced the shares outstanding—I’m sure I’ll be a year or two early, but at these valuations; this is one of those companies that you want to own. However, you can’t own it until you see the comp sales turn and that might be a few years in the future. Like most large companies that are cheap--what's the hurry?

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