Times have really changed for Big 5 Sporting Goods (Nasdaq:BGFV). Going public at $13 a share on June 25, 2002, it's been on a roller coaster ride ever since. Today, its stock trades around $7, almost half its IPO pricing from nine years earlier. Its margins have shrunk and although its best days appear to be in the rearview mirror, those with an appetite for risk will find its stock very rewarding. Here's why. (To learn more about the risk and reward relationship in investing, read Determining Risk And The Risk Pyramid.)
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Making Money
In the past decade, it's achieved an operating profit each and every year. That's the good news. Unfortunately, its operating margin has decreased in five of the last 10 years and now sits around 3.1%, 510 basis points lower than 2004, its record setting year when it generated $64 million in operating income on $782 million in revenue. Those were the days. California was doing okay, even choosing to elect Arnold Schwarzenegger Governor only the year before. Seven years on and the state's not faring nearly as well and it clearly is affecting Big 5's business. But not enough to drive it into the red and that's the silver lining here. The sporting goods business is slow growth, yet very resilient. Competitors such as Hibbett's (Nasdaq:HIBB) and Dick's Sporting Goods (NYSE:DKS) have also had problems over the past decade, but they too have always generated operating profits. From this perspective, the risk appears less lethal.

Stock Price
Big 5's been a public company for 110 months. In that duration, it's traded below $5 for just 68 days. It's safe to assume this is a strong floor price. Not coincidentally, its gross and operating margins at the time are almost identical to the present. Its second quarter report was mostly negative with some potential light at the end of the tunnel. Diluted earnings per share were 14 cents, 8 cents lower than a year earlier. The good news, however, was that revenues were flat in the quarter, increasing by $2.4 million for the first six months of the year. It's almost as if the ship is slowly turning back into the wind. Analysts seem to have mixed feeling about its stock with ratings in recent days of 'buy,' 'neutral' and 'underperform.' Along with the ratings come price targets between $9.25 and $11.00. Doing a quick calculation using the Graham Number, I get a fair value of $11. However, that's based on a trailing 12-month EPS of 76 cents. By the end of the year, I expect that number will be around 45 cents, much lower than the analyst estimate of 64 cents. If so, you're looking at a fair value of $8.49. Big 5 has a history of earnings surprises both positive and negative, so it's difficult to pin down. Nonetheless, I believe much of the bad news is already factored into the stock price.

Dividend
This is the most important piece of information in my opinion. Big 5 pays a quarterly dividend of 7.5 cents providing a yield of 4.3%. It's paid a dividend since 2004. Even with earnings per share of just 45 cents, its worst result in 10 years, its payout is only 67%. It has enough cash resources to keep the dividends flowing until business improves sometime in 2012. Risk averse investors will undoubtedly have a hard time pulling the trigger on this one but those willing to make the sacrifice will be well compensated for their patience. A majority of Big 5's stores are in states hit hard by unemployment and the housing crisis. Once these two stressors lessen, the upside is really quite inviting.

The Bottom Line
Whether we're talking about direct competitors like Hibbett's or Dick's or big-box peers like PetSmart (Nasdaq:PETM) or Best Buy (NYSE:BBY), they all have better operating margins than Big 5 despite having similar gross margins. This tells me Big 5's not nearly as efficient. Management will figure out how to fix this underperformance or they'll be bought out by someone who will. Either way, it will be at a price higher than $10 a share. (For more on underperformance, check out Analyst Recommendations: Do Sell Ratings Exist?)

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