Best Buy is not a Value Investment

by JT McGee

Companies like Best Buy give value investing a bad name.

Somewhere along the line investors decided to enjoy complete perversion of the value investing mantra. At some point, someone decided that any company selling for dirt cheap was a “value investment.”

This kind of thinking is fundamentally flawed, and its prominence is one of the many reasons why investors shy away from active portfolio management.

No Lingering Value

Value investors don’t want cheap. I mean, we want cheap, but it’s not the only thing that governs a portfolio. As a value investor, I want to beat the risk-free rate on US Treasuries handily while accepting the same amount of risk. That is to say that value investors want to buy companies that can generate returns greater than US Treasury bonds while being just as safe.

Few companies are as safe as US Treasury securities, which pay out as long as the lights are on. That doesn’t mean they don’t exist. But let’s stick to Best Buy and talk about why the company offers absolutely zero safety to investors in the common equity.

Best Buy does not have:

  1. A moat – There is nothing that gives Best Buy a competitive advantage over competitors like Amazon.
  2. Pricing Power – Prices for most electronics are set by the manufacturer, and retailers are allowed to diverge only slightly from set pricing.
  3. Unique products – There is nothing inherently different from a Microsoft Webcam for $25 at Amazon and $30 at Best Buy.
  4. A brand worth a hoot – People over 50 (people who would actually buy an electronic product offline) hate Best Buy and their annoying sales clerks.
  5. A brand worth a hoot pt. 2 – Best Buy destroyed their brand name with people under 50 with Geek Squad. Steve Jobs would call this sales force disguised as a computer repair service a “brand withdraw” from the “brand bank account.” (See an epic YouTube video of Steve Jobs on branding.)

Price vs. Value

Value investors are people who want long run returns greater than the risks of a particular investment. More importantly, value investors want to never lose. Value investors realize that if you never lose, you never need big, massive winners to outperform.

This is part of holding a company forever. The best companies are those that stand the test of time, and Best Buy is not one of them. Best Buy could, for a long time, make billions of dollars because it was the middleman between distributor and customer. Today it’s the most expensive of these middlemen, and consumers are price sensitive.

The internet has and will continue to kill the big box store model. So far, only the nerdiest of retailing companies have experienced the internet effect. But that’s just the starting point. Every other big box retailer will have to make a go of smaller stores (Best Buy’s preferred way to “save face”) before ultimately giving up to online retail.

Best Buy’s heyday is over. And it’s not a value investment.

{ 5 comments… read them below or add one }

20's Finances April 10, 2012 at 21:47

I agree – Best buy reminds me of circuit city, which I think either went out of business or closed a lot of stores a couple years ago.

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JT McGee April 12, 2012 at 08:14

Yep. Nothing special about retail, especially when there’s no difference between products from store to store. In a commoditized market like this, you have to compete on price – and Best Buy simply cannot be the lowest cost retailer for electronics or media.

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Financial Uproar April 14, 2012 at 22:59

So you think you can come on my site and play devil’s advocate and not have me return the favor? You are mistaken.

1. Something like 40% of BBY’s online purchases are picked up in store. There’s a certain segment of the market that doesn’t want to wait or pay for shipping.

2. One of AMZN’s big advantages is people buying from there don’t have to pay sales tax. Considering the finances of all levels of government, this will change. It’s only a matter of figuring out the details of how it’ll work.

3. Can this price battle really continue? AMZN had operating margins of only 1.5% in Q4. They set records in revenue, but didn’t come close to matching last year’s earnings. Amazon’s strategy of revenue growth at all costs isn’t really working out. How long until they abandon it and take some pressure off BBY? If you exclude their giant write-off, BBY’s operating margin was about a billion times better than AMZN’s in the all important 4th quarter. I’d take better margins and stagnant revenue over revenue growth at all costs any day.

Saying that, I don’t hold any Best Buy and wouldn’t look at it unless it was probably cut in half from these levels. It’s just not that exciting at $22 a share.

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JT April 15, 2012 at 08:51

I love devil’s advocates. We need more of them. Here’s my counterview: 😉

1. Yeah, people buying TVs (or other heavy stuff) – a low-margin product. Shipping costs are baked in at every retailer, online or offline. It’s just more noticeable in the heavy stuff, and I would say that it’s TVs/desktop computers or other junk that is picked up in store.

2. I really think this is a minor long run concern. Either the tax codes will be changed, or they won’t. Fairly unimportant, IMO, since taxes are not priced into the prices listed online until you check out. Apples to apples comparison = AMZN still has pricing edge.

3. Someone will always play the “let’s do it cheaper!” game. Unless there is something that makes your business unique, you can’t keep pace. Best Buy can’t keep pace in this category. For clarity: I’m not an AMZN or BBY shareholder either, and would not recommend AMZN as an alternative. The two can go to town with one another, but AMZN will win out, as it can actually afford to drive down costs to put BBY in its place. Personally, I think a play on ground shipping companies is a much better way to play online retail. There’s a real economic moat in ground shipping, and much better valuations. FDX at $60 during Greece’s temper tantrum was stupid cheap – and arguably FDX is still cheap near $90.

BBY has a better operating margin…in 2012. Previous years have been the same, yet BBY’s prices are higher than Amazon’s. Amazon can and likely will put BBY out of business in media and general electronics within the next decade. BBY’s only shot is, in my view, the Best Buy Mobile stores that it has consistently delayed. Its main competitor in that space (Radioshack) is arguably far better capitalized today than when initial plans were made. Best Buy should have pulled the trigger then, knocked off RSH and gotten into the smaller model. Now it’s stuck in a commodity category with two better capitalized companies beating it on both a warehouse model (Amazon) and smaller footprint stores (Radioshack.)

Retail is a waste of space, both in real life (seriously, do we need 50k sq/ft stores in any city?) and in my portfolio. Best Buy, though, is both a retailer, and a pretty awful company as far as protecting and growing my money.

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101 Centavos April 15, 2012 at 13:55

Or, you could invest in a REIT that rents warehouse space to FDX on a long-term basis. That’s a play on online retailing twice removed…

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