Following sub-par first quarter results, shares of Best Buy (BBY) have fallen to a level such that its P/E is now 11. Unlike some of the other low P/E stocks we have discussed on this site, however, Best Buy generates returns on capital of around 20% per year. And it does this consistently.
What likely helps Best Buy maintain such steady returns is the nature of its competitive advantage. Unlike companies that have to continually invest to maintain their advantages (e.g. pharmaceuticals, smart-phone makers etc.), Best Buy gets to profit off of the product innovations of others, by relying on its already-established distribution network.
It does face competition from other retailers (both bricks and mortar as well as online), but the risks to its business are easier to see in advance and easier to protect against than say a company hoping to bring a new drug to market or a company trying to hit a home-run with a new technology it hopes consumers will adopt.
This year appears to be shaping up in a similar way, as the stock has gone as high as $48, but has fallen by more than 25% from those levels. Much of that drop can likely be attributed to a shortfall in the latest quarter's earnings. But besides the fact that the first quarter is a nothing quarter for a retailer like Best Buy (almost 60% of the company's annual profit comes from the Christmas quarter), basing a company's value on anyquarter is not a sound way to invest. This is exactly the kind of short-term thinking in which the market participates, however, which allows long-term investors to profit.
Disclosure: Author has a long position in shares of BBY
About the author:
Saj Karsan founded an investment and research firm that is based on the principles of value investing. He has an MBA from the Richard Ivey School of Business, and an undergraduate engineering degree from McGill University.
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