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Three Ways To View Value Retail
The Motley Fool recently ran an article highlighting the 15 best values in retail. The author uses forward P/E as the criterion for ranking the stocks, and only those with total debt less than 60% of capital and annual earnings per share growth of 5% or more qualify. The list provides an interesting group of possibilities. The stock with the lowest forward P/E is GameStop (NYSE:GME), the world's biggest video game retailer. Before I crown it the best value stock in retail, I'll apply three additional criteria to determine the true champion.
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Magic Formula
Most investors by now are familiar with Joel Greenblatt's Magic Formula - his simple way to beat the markets. He takes a large group of stocks and ranks them from best to worst in terms of return on capital and earnings yield. For this article, we will use only the top five. At home, you might want to do all 15. In addition, we're using the most recent quarter for the balance sheet, and the most recent year-end for the income statement. This too was for brevity. The trailing-12 months will give you a more real-time look at how each company is performing. However, this is for comparative purposes only. It gives me a good snapshot how each is utilizing its assets, and how cheap its stock is. GameStop is the clear winner, according to the Magic Formula.
My Own Quick Screen
Over the years, I've developed a number of my own valuation tools to assess a stock's attractiveness. Because we've already used P/E, I'll substitute the PEG ratio. Normally, I multiply price-to-book, price-to-sales, trailing P/E and price-to-cash flow with any result less than 300 worth looking at more closely. However, because my third way of looking at retail value involves free cash flow, I've taken out P/CF as well. Therefore, only three numbers (P/B, P/S, PEG) apply. Those with a product less than 10 get a second look. For comparison purposes, Lululemon's (Nasdaq:LULU) score is 42.
Free Cash Flow
I happened to come across an article in Seeking Alpha where Peter Psaras performed a backtest between the Dow Jones Industrial Average from 1950 to 2007 and purchases of those Dow stocks whenever they were trading for less than 15-times free cash flow. While I haven't taken the time to substantiate the numbers, Psaras' backtest highlights the importance of free cash flow. In a 2009 article about Coach (NYSE:COH), he illustrates the effectiveness of buying stocks trading at low multiples of free cash. Last year, you could have bought the maker of luxury bags at less than eight-times free cash, the first time in over a decade. Since hitting a low of $16.48 in March, 2009, it's up over 124%. Compelling evidence, indeed.
The Bottom Line
While Collective Brands is at the top of the pile in two of the three tables, in the end I'd go with GameStop, despite heavy competition from Walmart (NYSE:WMT) and Best Buy. It generates a lot of cash while using far less debt than Collective. Think margin of safety. (For related reading, take a look at Take On Risk With A Margin of Safety.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
Magic Formula
Most investors by now are familiar with Joel Greenblatt's Magic Formula - his simple way to beat the markets. He takes a large group of stocks and ranks them from best to worst in terms of return on capital and earnings yield. For this article, we will use only the top five. At home, you might want to do all 15. In addition, we're using the most recent quarter for the balance sheet, and the most recent year-end for the income statement. This too was for brevity. The trailing-12 months will give you a more real-time look at how each company is performing. However, this is for comparative purposes only. It gives me a good snapshot how each is utilizing its assets, and how cheap its stock is. GameStop is the clear winner, according to the Magic Formula.
|
Magic Formula Ranking |
|||
|
Company |
Return on Capital |
Earnings Yield |
Overall Rank |
|
GameStop (NYSE:GME) |
62.1% |
21.8% |
1 |
|
Best Buy (NYSE:BBY) |
38.8% |
16.9% |
2 |
|
Rent-A-Center (Nasdaq:RCII) |
41.9% |
15.8% |
2 |
|
Collective Brands (NYSE:PSS) |
14.3% |
11.9% |
4 |
|
Dress Barn (Nasdaq:DBRN) |
12.9% |
7.7% |
5 |
Over the years, I've developed a number of my own valuation tools to assess a stock's attractiveness. Because we've already used P/E, I'll substitute the PEG ratio. Normally, I multiply price-to-book, price-to-sales, trailing P/E and price-to-cash flow with any result less than 300 worth looking at more closely. However, because my third way of looking at retail value involves free cash flow, I've taken out P/CF as well. Therefore, only three numbers (P/B, P/S, PEG) apply. Those with a product less than 10 get a second look. For comparison purposes, Lululemon's (Nasdaq:LULU) score is 42.
|
Morningstar Quick Valuation |
||||
|
Company |
P/B |
P/S |
PEG |
Total |
|
Collective Brands (NYSE:PSS) |
1.1 |
0.3 |
0.5 |
0.17 |
|
GameStop (NYSE:GME) |
1.1 |
0.3 |
0.6 |
0.20 |
|
Best Buy (NYSE:BBY) |
2.1 |
0.3 |
0.6 |
0.38 |
|
Rent-A-Center (Nasdaq:RCII) |
1.0 |
0.5 |
0.9 |
0.45 |
|
Dress Barn (Nasdaq:DBRN) |
1.7 |
0.8 |
0.8 |
1.09 |
I happened to come across an article in Seeking Alpha where Peter Psaras performed a backtest between the Dow Jones Industrial Average from 1950 to 2007 and purchases of those Dow stocks whenever they were trading for less than 15-times free cash flow. While I haven't taken the time to substantiate the numbers, Psaras' backtest highlights the importance of free cash flow. In a 2009 article about Coach (NYSE:COH), he illustrates the effectiveness of buying stocks trading at low multiples of free cash. Last year, you could have bought the maker of luxury bags at less than eight-times free cash, the first time in over a decade. Since hitting a low of $16.48 in March, 2009, it's up over 124%. Compelling evidence, indeed.
|
Price To Free Cash Flow |
|
|
Company |
P/FCF |
|
Collective Brands (NYSE:PSS) |
4.0 |
|
GameStop (NYSE:GME) |
6.2 |
|
Best Buy (NYSE:BBY) |
7.4 |
|
Dress Barn (Nasdaq:DBRN) |
8.5 |
|
Rent-A-Center (Nasdaq:RCII) |
9.9 |
While Collective Brands is at the top of the pile in two of the three tables, in the end I'd go with GameStop, despite heavy competition from Walmart (NYSE:WMT) and Best Buy. It generates a lot of cash while using far less debt than Collective. Think margin of safety. (For related reading, take a look at Take On Risk With A Margin of Safety.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
by
Will Ashworth
Will Ashworth lives and works in Toronto, Canada. He's worked in and around the financial services industry for much of his adult life. He loves investing and is passionate about helping others learn how to put their money to work.
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