Streetwise

Lauren Rudd

Sunday, May 4, 2014

Price Declines Can Translate to Profits

Many investors live in fear of a major decline in the financial markets and subsequently in the value of their portfolio. To them, this equates to poor stewardship and is synonymous with disaster and ruin.

John Maynard Keynes, the renowned British economist and a very successful investor, made some astute comments regarding declining stock prices in the aftermath of the 1937 recession.

To paraphrase, he said that selling at low prices is not a remedy for having failed to sell at high ones. While it clearly would have been advantageous to sell high, it would have required abnormal foresight.

Moreover, he pointed out that it is not the business, far less the duty, of a serious investor to be constantly considering whether to cut and run, or to feel open to blame if the price of a stock depreciates.

From time to time, noted Keynes, a serious investor must accept share price depreciation with equanimity and without reproach. An occasional share price decline is inevitable. Yet to know exactly when requires a crystal ball. And the possibility of a decline should not equate to panic or a fire sale.

Actually, substantial price declines offer up one of the easiest ways to create substantial returns. While not always easy to find, you want to look for quality companies that are trading at 52-week lows resulting from short-term weakness.

Bed Bath & Beyond (BBBY) might just be such a candidate. The shares traded recently at $62.13, just above its 52-week low of $61.70, creating a possible entry point if you are looking to capitalize on short-term weakness.

The retail giant reported fiscal 2013 sales of $11.504 billion, an increase of approximately 5.4 percent when compared to 2012. Comparable store sales increased by approximately 2.4 percent compared with an increase of approximately 2.7 percent a year ago. Earnings were $4.79 as compared to $4.56 per share a year ago.

However, Bed Bath & Beyond surprised the Street on April 9, when it announced a rather dismal guidance of $.92 to $.96 in earnings per share for the fiscal first quarter of 2014 and a mid-single digit percentage increase in earnings for fiscal 2014.

While no one would say that 2013 was an impressive year, it was not bad when you take into account $0.06-$0.07 EPS lost due to weather-related store closings and the previous year having an extra week included. Factor that in and you have an increase of over 7 percent in revenue and EPS. Again, while not overly impressive, it does not warrant a 20 percent decline in share price and $3.5 billion loss in market capitalization (number of shares multiplied by share price).

Moreover, Bed Bath & Beyond appears to be at the top of its game. With the home-goods and decor industry on an uptrend and trading at 13 times earnings, the retail giant appears to have excellent long term prospects. In addition, the shares are currently below their 50-day moving average and over the past 5 years the share price has tracked closely to its 50-day moving average.

With a trailing 12-month EV/EBITDA or enterprise multiple of 6.54, the value proposition is even more apparent. Note that EV or enterprise value is often thought of as a theoretical takeover price. It is calculated as market cap plus debt, minority interest and preferred shares, minus total cash and cash equivalents. EBITDA is earnings before interest, taxes, depreciation and amortization. This is a more definitive ratio than price-to-earnings or P/E.

Bed Bath & Beyond has appreciated more than 100 percent over five years. While not tremendous, it is steady and convincing. Moreover, despite projecting modest growth in 2014, management has built an amazing business. With an above-average 25.9 percent return on equity, the company’s ROE is higher than both Target and Wal-Mart with virtually no leverage.