Streetwise

Lauren Rudd

Sunday, October 16, 2011

Research is the Name of the Game

It seems that there is a resurgence of concern over the volatility and greed that continually drives the investment world. I hate to mention this but it has always been that way. Why do you think Occupy Wall Street came into existence?

And the Street’s professionals are quick to profit from the errors and poor judgment of the less informed. If you are tempted to simply jump in to collect your share of the spoils, forget it. For the average investor trying to outmaneuver the Street is like trying to herd cats, a great idea but one with little probability of success.

Nonetheless, Wall Street still offers up the greatest potential for accumulating wealth. However, you are obligating yourself to undertaking a degree of necessary research. Simply taking the word of others will at best limit your gains. At worst, you become an easy meal of raw meat.

Furthermore, the days of buy and hold with unremitting patience are long gone. The decision to sell is as important as deciding what and when to buy. Again, research is the key.

Complicating matters is the critical allocation between bonds and stocks. Academic studies have shown that decision can account for 90 percent of your investment success. So how you select an optimum mix? No, 60-40 or 40-60 does not work. It requires an analysis of a myriad of economic factors. Translated...that means more research.

Moreover the performance of an index, such as the Dow Jones Industrial Average, has little or no correlation to the performance of your portfolio or that of a particular stock, other than some meaningless day-to-day price volatility.

So what do you do and where do you begin? One company you might want to research is Staples, a company I have not talked about for a couple of years. Staples recently released results for its fiscal second quarter ended July 30. Sales for the quarter increased 5.2 percent to $5.8 billion year over year. Net income increased 36 percent to $176 million, while earnings, on a GAAP basis, increased 39 percent to $0.25 per share from $0.18 a year ago.

Adjusted, meaning non-GAAP, second quarter earnings increased 10 percent to $0.22 per share as compared to the $0.20 per share achieved in 2010. The adjustment excludes a $21 million cash tax refund during the second quarter of 2011 and pre-tax integration and restructuring expense of $22 million during the second quarter of 2010.

The retail giant generated operating cash flow of $302 million and has invested $164 million in capital expenditures year-to-date. This has resulted in a free cash flow number of $138 million for the first half of 2011. At the end of the second quarter, the company had $1.8 billion in liquidity, including $823 million in cash and cash equivalents.

Staples repurchased 12 million of its own shares, spending $199 million during the second quarter. Year-to-date the company has repurchased 19 million shares, spending $346 million.

The company’s third quarter guidance shows sales increasing in the low single-digits compared to the same period of 2010, while earnings are expected to be in the range of $0.46 to $0.48 per share. For the full year, Staples expects sales to increase in the low single-digits with earnings in the range of $1.42 to $1.48 per share.

Excluding the second quarter tax refund of $0.03 per share, the company says earnings for the year should range between $1.39 and $1.45 per share. For the year, free cash flow is expected to exceed $1 billion, even after spending approximately $400 million for capital expenditures.

The intrinsic value of the shares using a discounted earnings model, with a conservative 5-year average earnings growth rate of 12.63 percent and a 15 percent discount rate, is $26 per share. The more conservative free cash flow to the firm model produces an intrinsic value of $34 per share. The shares recently closed at $14.40.