Warren Buffett is justifiably considered as one of the most successful investors of all time. The methods he employs to identify long-term investment opportunities have been thoroughly documented, by himself and others, and copied by value-oriented investors for decades. The annual reports he writes for Berkshire Hathaway are considered required reading in many investor quarters for the insights they give about his investing approach and its use under current market conditions, and market media outlets pay close attention to any opinions he renders about the economy or the market in general.
One of the outcomes of Mr. Buffett’s success is that his observations about investing, the markets and the economy in general make for great sound bites that many of us who try to model his approach use to encapsulate elements of our own strategies. One of my personal favorites is his definition of value investing as buying a “good company at a nice price.” Those two terms are both important to understand in their proper context, especially when current market conditions are pushing stock prices off of their all-time highs, to multi-year low levels.
It’s pretty natural to look at a stock that has been dropping in price, especially for an extended period of time, and to start wondering if the stock’s drop means there is a useful new opportunity to be had. After all, we’re all looking to “buy low, and sell high” later, so no matter whether you prefer a short-term, swing trading method or a longer-term, fundamentally driven strategy, lower prices should naturally start to make you think about if the stock you’re looking at could be worth your hard-earned investment dollars.
The market is also pretty good, in the long-term at least, at pricing a company’s underlying business strength – what you might think about as its fundamental quality – into a stock’s market price. That means that while stock prices can be driven by market forces like broad economic uncertainty or geopolitical pressures – hello, trade war, interest rates, and global economic slowness – in the long-term, they tend to be driven by the stability and effectiveness of the underlying business itself. If a company is well-managed and showing that it has the ability to grow its business effectively, the market will usually factor that into the stock price by pushing it higher in the long run. This idea is a core tenet of what analysts and economists generally refer to “efficient market theory.”
Efficient market theory also folds back into my favorite Warren Buffett quote, because it means that just because a stock is trading at low levels – what might be a “nice price,” you have to be careful not to automatically assume that it is also a “good company.” Sometimes a stock is cheap for important reasons, and that longer trend should be taken as a sign to stay away, because the company’s fundamental quality just doesn’t support the idea that the stock is worth more than it is right now. That’s why I draw a line to differentiate between stocks that I think are a bargain – good, fundamentally strong companies trading a discounted stock prices – and cheap stocks. To me, cheap stocks are cheap for a reason and will usually stay cheap for the foreseeable future.
This morning I look a look a stock that I’ve followed off and on for quite some time, Bed Bath & Beyond (BBBY), and these basic value concepts came quickly to mind. This is a stock that has been following a steady downward trend for almost five years, declining from an all-time high around $80 to its current level a little above $12 per share. Over the past year, the stock is down more than 48%, and nearly 13% in just the last month. That decline has been driven by persistent concerns about the company’s ability to adjust and survive in a changing retail environment that is increasingly placing less value on traditional brick-and-mortar stores and more on omnichannel sales. The company has been working to shift its focus to a more web-driven strategy, but even that is being viewed with a fair degree of skepticism by Mr. Market since online sales generally translate to much narrower margins.
This kind of long-term downward trend generally doesn’t happen unless there are critical, fundamental reasons behind it. So while the stock is, by most valuation metrics I like to use, definitely underpriced, I hesitate say that it is a bargain because of the critical questions that persist about the company’s strategy and focus. There are some interesting fundamental strengths that work in this company’s favor, however that might prompt you to believe otherwise. Let’s take a look.
Fundamental and Value Profile
Bed Bath & Beyond Inc. is a retailer, which operates under the names Bed Bath & Beyond (BBB), Christmas Tree Shops, Christmas Tree Shops andThat! or andThat! (collectively, CTS), Harmon or Harmon Face Values (collectively, Harmon), buybuy BABY (Baby) and World Market, Cost Plus World Market or Cost Plus (collectively, Cost Plus World Market). The Company operates in two segments: North American Retail and Institutional Sales. The Company sells a range of domestics merchandise and home furnishings. Domestics merchandise includes categories, such as bed linens and related items, bath items and kitchen textiles. Home furnishings include categories, such as kitchen and tabletop items, fine tabletop, basic housewares, general home furnishings, consumables and juvenile products. The Company operates approximately 1,530 stores plus its various Websites, other interactive platforms and distribution facilities. BBBY has a current market cap of about $1.7 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings declined -52%, while revenues were mostly flat, at -.05%. The picture did improve in the last quarter, as earnings picked up by 12.5%, while sales increased a little over 6.5%. The company’s operates with a very narrow margin profile that is constricting even more, since Net Income as a percentage of Revenues dropped to 1.65% in the last quarter versus 2.81% over the last twelve months. I read this as a clear reflection of the company’s strategy and effort to evolve their business to include a larger emphasis on online sales and revenues. That could keep pressure on the company’s bottom line, but if these numbers start to stabilize – particularly Net Income, which has been declining steadily since late 2014 – it could be a sign that their efforts are gaining positive traction and the strategy is working.
- Free Cash Flow: BBBY’s free cash flow is very healthy, at $753 million over the last twelve months. This is a major increase over the past year, from a low at about $483 million in the fourth quarter of 2017. This number also translates to an outsized Free Cash Flow Yield of 47.5%. This is an interesting counter the company’s narrow, constricting margin profile and could be an early indication that the company is doing the right thing, and it is starting to work.
- Debt to Equity: BBBY’s debt/equity ratio is conservative, at .51. The company’s balance sheet shows that long-term debt is a little less than $1.5 billion, while cash and liquid assets around a little over $1 billion. The company’s narrow margin profile calls into question their ability to service their debt on operating profits alone, but their sizable cash position means that they can comfortably cover any operating shortfall. It should also be noted that since the fourth quarter of 2017, their cash and liquid assets have increased from a low point at about $350 million.
- Dividend: BBBY’s annual dividend is $.64 per share, which translates to a yield of 5.13% at the stock’s current price. That is a very attractive yield, and could be an interesting draw reason to think about taking a long-term position if you think the stock’s current price reflects a useful bargain.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value. BBBY has a Book Value of $21.02. That translates to a Price/Book ratio of .57, versus a historical ratio of 2.38. Forecasting a 400%+ increase in the stock’s price would put it above $50 per share, which is a level the stock hasn’t seen since late 2015. I think that is over-optimistic given the long-term strength of the downward trend, but the stock’s Price/Cash Flow ratio provides a somewhat more conservative forecast, since it is trading about 273% below its historical average and puts that target price around $32. That price level was last seen in mid-2017.
Here’s a look at the stock’s latest technical chart.
- Current Price Action/Trends and Pivots: This is a two-year chart that clearly shows the strength of the stock’s downward trend; the stock appeared to be showing some interesting signs of consolidation from April through September of last year, but then broke down in a big way at the beginning of October, which precipitated the stock’s decline to its current levels. More recently the stock stock appears to have rebounded from low around $10.50 that is the lowest level it has seen so far in the 21st century. The low end of last year’s consolidation range is around $17, and the stock would need to push above that level at minimum to establish any kind of sustainable rally that could reverse the stock’s more than four-year downward trend.
- Near-term Keys: Despite the intriguing possibilities the stock’s current valuation metrics suggests, I’m not confident the stock is likely to rally anytime soon. The fundamentals are mostly solid, so there is a good argument to be made that BBBY isn’t just a cheap stock, but I would prefer to see the company’s margin profile stabilize, or even show signs of improvement before I buy into the stock’s value proposition. I also don’t think, however that there are good reasons to look for any kind of bearish trades, either by shorting the stock or working with put options. The break above $17 I mentioned earlier is the minimum price level I would look to for any kind of bullish trade, on either a long-term or short-term basis.