Best Buy Stock As A Long-Term Investment

For a company with a wildly impressive track record of rewarding shareholders, Best Buy sure is an ugly company. Since 1985, Best Buy has compounded wealth for shareholders at a rate of 20.58% annually for shareholders. Yes, this is a company that has been even better than the quintessential dividend stock of the Old Philip Morris, which has rewarded shareholders with huge dividend checks that now come from Altria, Philip Morris International, Kraft, and Mondelez. A mere $10,000 invested into Best Buy in 1985 would be over $2,612,000 today. Millionaire status could have been reached with a mere $3,850 investment in Best Buy.

Yet, we are here to talk about the future (as Buffett said, the investor of today does not profit from yesterday’s growth) and the particularly difficult insights to get right are the ones that the future departing from the past. In the case of Best Buy, it is my contention that the future will be much worse than its past.

This is a company that has been driven to the brink by competition with Wal-Mart and Amazon. Remember how Border’s and Barnes & Noble ran into trouble because people frequent their bookstores to find items they wanted to buy, and after figuring out what they wanted, would look up comparison prices online before making their decision? If you thought people do that with $20 books, boy do they do that with electronic goods that cost in the hundreds of dollars.

Best Buy’s profit margins have plummeted, and I would argue, this is a near permanent event. Before 2007, Best Buy was a company that enjoyed profit margins between 3.5% and 6.0% in a given year. Like Wal-Mart, it was a high-volume producer, but unlike Wal-Mart, it tended to be about twice as profitable on items. Before internet commerce was popular—in the era when people believed that visiting Best Buy imparted a certain expertise that created a great experience worth paying a premium—Best Buy was able to make shareholders really rich by selling a lot of goods at a decent profit margin.

Since the internet age, the story at Best Buy has changed. Profits margins have fallen to 2.1%, and were 1.7% last year. Over half of the company’s stores were closed in short order. There were 4308 Best Buy locations in 2011. Now, there are 1,950 stores. They have stock buybacks—particularly between 2006 and 2007 as well as between 2010 and 2011—to hide the deterioration in the core business. There were 460 million shares in 2006. There are 350 million today. If profits remained stagnant, that 110 share reduction means that every share of Best Buy you own today is entitled to 23% more profit today.

The 2006-2007 buyback retired 70 shares, and the 2010-2011 buyback retired 50 million shares. In 2012 and 2013, the shareholders got diluted so that explains why shares have only decreased to the tune of 110 million even though ’06-’07 and ’10-’11 retired 120 million shares. This buyback program has covered up the lower profits generated at Best Buy—in 2006, Best Buy the company made $1.37 billion in annual profit. This past year, Best Buy made 860 million. The reason why earnings have only declined a bit ($2.79 to $2.45) is because of that buyback program.

This is a company that once was a wonderful asset—in the 1980s and 1990s, new stores rolled out that sold more goods at healthy margins and made shareholders rich. That isn’t the case anymore—margins have been structurally lower since internet commerce became widespread, and the current business model does not stand much of a chance of growing earnings per share at anything resembling a rate that you’d get from an index fund. This does not mean that I am predicting of Best Buy in short order. The company has a surprisingly clean balance sheet, with only $1.6 billion in debt that only requires $100 million in long-term interest, has no finance capital leases with hell-or-highwater provisions, and has a very cash position with $3.3 billion on hand. It has room for yet another one-year buyback trick up its sleeve. It’s still profitable. However, if you are someone who is aiming to make capital decisions today that can remain untouched for 20+ years, this company is not that type of candidate. It’s about one step above what Warren Buffett called cigar-butt stocks that have one puff left in them, and it is up to you to decide what you want to do with that information.

Originally posted 2015-03-04 23:16:02.

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