Streetwise
Lauren Rudd
Sunday, July 13,
2008
Do Not Let Your Bias Dominate
In early October, 1929, a few days before the market crashed,
Irving Fisher, a well known monetary economist, confidently predicted that,
"Stock prices have reached what looks like a permanently high plateau." Not to
be dissuaded, for months after the market crashed, Fisher continued to assure
investors that a recovery was just around the corner.
Fisher’s mistake, which is so often repeated by others, is
that he was blind sided by his own biases. Although Fisher’s investment demise
resulted from an overly positive outlook, the reverse can occur just as
frequently, if not more so, and can be just as deadly to the overall performance
of your portfolio.
Letting your emotions or personal bias drive your investment
strategy can be expensive. Let me offer a more profitable approach. If a company
has historically strong fundamentals, a solid business plan going forward,
astute management and you understand the company’s business philosophy, then buy
the shares and hold them with the understanding that share prices will fluctuate
somewhat in sync with overall market direction.
Also, remember that almost every company at one time or
another finds itself at the mercy of speculators and short-sellers, not to
mention the capricious opinions bandied about by analysts. The result is greater
volatility in conjunction with a lower stock price. Notice that I excluded the
inherent strength of the financial fundamentals from playing a role. More often
than not it doesn’t.
Consider, for example, Bed Bath & Beyond (BBBY), a company I
last wrote about a year ago and one where exogenous events have played havoc
with a solid business plan and astute management. Operating under names that
include Bed Bath & Beyond, Christmas Tree Shops, Harmon and Harmon Face Values,
and buybuy BABY, as of March 1, 2008, the company operated 881 BBB stores, 41
CTS stores, 40 Harmon stores and 9 buybuy BABY stores.
Net earnings for the fiscal year ended March 1, 2008 were
$562.8 million or $2.10 per share, as compared with $594.2 million or $2.09 per
share a year ago. However, the March 2007 number was for 53 weeks, not 52, and
did include a non-recurring charge of approximately $.07 per share. Net sales
for fiscal 2007, were approximately $7.049 billion, an increase of 6.5 percent
from the prior fiscal year. Comparable store sales saw a 1.0 percent increase.
For its fiscal first quarter ended May 31, Bed Bath & Beyond
posted earnings of $76.8 million, or 30 cents per share, beating the Street
consensus of 27 cents. Unfortunately, margins eroded somewhat with gross margin
falling 180 basis points to 39.8 percent. Operating margin was 7.2 percent,
while the net profit margin was 4.7 percent of sales.
The good news is that core free cash flow remained strong at
$70 million and management has indicated that they are expanding the company's
store base slowly, while taking advantage of bargain leasing opportunities that
arise in today’s real estate market.
The intrinsic value of the shares, using a discounted
earnings model with an 11 percent discount rate and an average earnings growth
rate of 10 percent, is $53 per share. A free cash flow to the firm model
produces an intrinsic value of $59 per share. My earnings estimate for this
fiscal year is $1.90 per share.
After hitting a one-year high of $37.61 last June, the shares
fell to a low of $24.49 in January. My 12 month target price on the shares going
forward is $33 for a potential capital gain in excess of 15 percent over the
recent price of $28.68.
As you look at your investments, keep in mind that it will likely take at least
another year, and maybe two, but the economy will recover. When it does, the
performance of chains like Bed Bath & Beyond will exceed current projections.
