Best Buy Is A Value Trap

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Despite the challenges, the company’s solid fundamentals make the stock especially attractive for long-term investors.  The shares are trading at a historic low multiple of about 12.5 times estimated fiscal 2009 earnings…. In more normal times, the stock trades at a multiple from 15 to 18 times earnings…..

“Consumers Turned Off? Not At Best Buy”, Barron’s, Saturday March 22

In my Bear Market Talks I’ve been warning people about value traps.  A value trap is generally the stock of some well known company in a beaten down industry that looks great by the numbers. 

However, this superficial analysis is misleading because the business is struggling so much that numbers are likely to come in mediocre at best – making any real stock gains unlikely.

I think Barron’s fell into this trap with a piece a couple weeks ago recommending Best Buy’s shares. 

Today’s earnings release from Best Buy (BBY) confirms this for me (BBY FY 4Q Earnings Release).

Excluding the impact of an extra week in the comparable period last year, revenues grew 9% and EPS 14%.  Looks pretty solid, right?

However, when you look beneath the surface you can see how much Best Buy’s business is really struggling. 

The 14% EPS increase was driven almost entirely by a huge share buyback program.  There were about 13% less diluted shares this quarter than last.  So, when you take out the share buybacks, organic earnings growth, growth in the actual business, was really only about 1%.

Revenue growth, in turn, was entirely a function of adding new stores – 137 in the past 12 months.  Same store sales were down .2% – and down .9% in their core US business.  That means that stores that have been open for 14 months actually sold less in the just completed quarter compared to last year.

Another number that caught my attention was the -4.6% comparable sales in their core Consumer Electronics segment.  So Barron’s anectdotal report about 22 year old David Mushrall and 24 year old Colin Lucas who each recently purchased flat screen TVs doesn’t mean that many others aren’t cutting back on their consumer electronics purchases.

In sum, there are lots of convincing arguments that can be made for Best Buy’s shares on a fundamental basis: down almost 20% from its 52 week high in December, trading for only 13 times forward earnings, the leading company in its space, etc…

But the weak economy will pressure the discretionary purchases that are their business resulting in lackluster business and stock performance.  You’ll have a chance to buy Best Buy at a better entry if you’re patient.

On the subject of value traps, also see my “The Limits Of Pure Fundamental Analysis – How Morningstar Gets Things Wrong”, Top Gun FP, September 27, 2006.  How’s Tuesday Morning (TUES) been for you as an investment Pat?

Disclosure: Top Gun has no position in Best Buy (BBY) shares.

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