Streetwise

Lauren Rudd

Sunday, February 26, 2012

Look Beyond Biases When You Invest

A deafening diatribe of commentary regarding current economic policy leads me to the conclusion that seldom have so many said so much about a subject about which they know so little. As Charles Darwin wrote, “Ignorance more frequently begets confidence than does knowledge.”

For example, without the various stimulus programs the economy would be in considerably worse shape than it is today. No matter how satisfying the concept of government austerity might sound it is diametrically the wrong answer in times of lethargic economic activity. Presidents Herbert Hoover and Franklin Roosevelt learned this the hard way.

Failure to envision the future objectively, without prior prejudice, is not limited to governments or the media.  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 blindsided 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.

Now that you have seen that letting emotion or personal bias drive your investment strategy can be expensive, let me offer a more profitable alternative. Search out companies you understand that have historically strong fundamentals, a solid business plan going forward and astute management.

A good example might be Bed Bath & Beyond (BBBY), the same retail chain that received tongue-in-cheek notoriety in the 2003 movie Old School, as Will Ferrell's character Frank rejects chugging a beer at a college party because he has a busy Saturday planned with his wife, stating "We're going to Home Depot - maybe Bed Bath & Beyond."

As of November 26, Bed Bath & Beyond had a total of 1,171 stores, including 993 Bed Bath & Beyond stores in all 50 states, the District of Columbia, Puerto Rico and Canada, 71 Christmas Tree Shops, 61 buybuy BABY stores and 46 stores under the names of Harmon or Harmon Face Values.

A year ago my earnings estimate for the company’s 2010 fiscal year ended February 26, 2011 was $2.90 per share and $3.33 for the 2011 fiscal year that ends February of this year, with a 12-month share price forecast of $55 per share. So how did the company perform?

Earnings for fiscal 2010 came in at $3.07 per share and the shares recently closed at $59.63, both numbers exceeding my forecast. A year ago the shares were trading at $47.45, thereby resulting in a 12-month capital gain of 24.8 percent. History is fine but what counts is the company’s potential going forward.

For fiscal 2011 third quarter ended November 26, Bed Bath & Beyond reported earnings of $0.95 per share, an increase of approximately 28 percent from a year ago. Third quarter sales were $2.344 billion, an increase of 6.8 percent compared to a year ago. Comparable store sales, or those stores open for at least a year, increased 4.1 percent, as compared to 7.0 percent a year ago.

For the nine months ended November 26, the Company reported earnings of $2.60 per share, an increase of approximately 33 percent, while sales were $6.768 billion, an increase of 8.2 percent.  Comparable store sales increased 5.5 percent, as compared to 7.6 percent the previous year.

The Company’s guidance going forward indicates earnings of $1.28 to $1.33 for fiscal fourth quarter and approximately $3.86 to $3.92 for the year.

The intrinsic value of the shares using a discounted earnings model with a five-year average growth rate of 16.4 percent and a discount rate of 15 percent is $100. The more conservative free cash flow to the firm model shows an intrinsic value of $175.