Sometimes the most valuable investment analysis - simple observation - can lead to valuable investment ideas. When it comes to used auto parts dealer AutoZone (NYSE:AZO), my observations were able to provide some very valuable information.
IN PICTURES: World's Greatest Investors
It Began with a Letter
Several months ago, I got a letter from my local Toyota dealership stating that they would give me a premium price for my used vehicle if I would purchase a new vehicle. With the economy in a recession, it's no surprise that people aren't buying new cars. However, I also discovered that people are keeping used cars on the road longer in order to save a few bucks. People weren't trading in used vehicles at any price. So I visited some local AutoZones and my thoughts were confirmed: business was picking up. (For more, see Your Car: Fixer-Upper Or Scrap Metal?)
Better than the Rest
When I analyzed AutoZone, I realized that it's a well-run business, which makes sense considering it dominates the used auto parts industry. As well, the stores are adequately staffed so they can provide excellent customer service, but still maintain a lean operating structure.
Today, AutoZone shares trade for approximately $155 a share or a P/E ratio of 15. It's the dominant player in the industry, yet it has the lowest P/E ratio within its peer group. Advance Auto Parts (NYSE:AAP) and O'Reilly Automotive (Nasdaq:ORLY) have P/E ratios of 16.5 and 24, respectively, while Pep Boys (NYSE:PBY) is currently without a P/E due to a bad year. AutoZone's operating margins, at 17%, fly by Advanced Auto and O'Reilly, both of which are in the single digits. (For related reading, see Analyzing Auto Stocks.)
Price Vs. Value
Many bargain hunters may be quick to dismiss a company with a P/E of 15 in today's world where many good businesses can be found trading for P/E multiples at half of that. However, AutoZone's history shows that it can weather the storm. AutoZone started 2008 trading at $116 a share and ended the year at $137 share, or an 18% return in a year in which the S&P 500 flopped more than 40%.
Sure AutoZone probably won't double in a year, but you don't get rich in the market by trying to find only multi-baggers; you succeed by finding great businesses that can continue to earn more profit year in and year out. Famed hedge fund manager Eddie Lampert apparently thinks so, as his firm, ESL, owns over 40% of the company.
I like my chances with auto parts, as consumers will make sure that they fix the asset that they rely on to get to and from work each day. In a normal environment, a one-of-a-kind business like AutoZone could easily command a P/E of 20. And like Buffett quips, it's far better to pay a "fair price for a great company than a great price for a fair company." AutoZone certainly falls into the former category. (For more, see Think Like Warren Buffett.)