Best Buy

So I had this lengthly post written out with detailed analysis on ten years of Best Buy annual reports, and at least three pages of valuation scenarios but then blogger deleted it all... OK maybe not, but I did I have an actual write-up written that got deleted, I don't have a lot of time now because I need to mow the lawn before I go to work so I'm just gonna put it through the The Warren Buffett Way, Second Edition list and if it passes I'll do some more extensive crap later.

Business

Simple and Understandable

Pretty much. Best Buy is the number one, basically the top dog, technology retailer. It's mainly Best Buy and Geek Squad, but other brands are listed here.

Circuit City is its only direct competitor - the only competitor who like it focuses on technology. It also competes with Wal Mart, Target, Costco, Sears, etc.

Consistent Operating History

Yes. Only one year that wasn't consistent in the past ten. Every other year showed ROE over 19% usually over 20.

Favorable Long-Term Prospects

Definitely. Management has shown ability to keep up its good profitability. Also it has no direct competitors that offer any sort of threat at all. Circuit City is kind of a joke comparatively, and I doubt Costco or Wal-Mart is going to randomly decide put Best Buy out of business tomorrow. Also its knowledgeable employees and Geek Squad are a massive help in buying decisions and later troubles and should be added as an intangible asset.

Of course I would not predict terminal growth of more than 1.5 or 2% simply because there aren't very many retailers still earning good returns on capital from 30 years ago.

Management

Rational?

From the annual report it seems like management is rational and knows what they're doing.

Candid?

The letter was very informative.

Resist Institutional Imperative?

Though the annual report had a lot of glossy pictures and looked like a marketing campaign, and some press releases had almost sleazy headlines, I'd say overall they resist the institutional imperative.

Financial

Return on Equity

Currently Best Buy has an ROE of 24%, and as previously noted only one time has it been lower than 19% in the past ten years. Add that to the fact that they devoted a page in the annual report to computing the return on capital and explaining it and I believe this is a company which focuses on ROE and will maintain a pretty high one.

Also Best Buy is short on debt with a D/E of .1.

Owner's Earnings

Income                  1377

+Depreciation           509

-CapEx                  733

=Owners Earnings        1153

Profit Margins

Though inherently low because it is a retailer its profit margins have been higher than the industry average in each of the last five years.

One Dollar of Market Value for Each of Retained Earnings

According to Quicken it has created $3 in market value for each in retained earnings easily passing this test.

Value

Best Buy is definitely more undervalued now that it has been in a few years, it trades for only 2/3 of sales and at a PE of only 16, which is lower than any average PE over the past ten years.

But according to Quciken it would need to grow earnings 11% annually over the next ten years to justify the current price. This does not leave a lot of room for error...

In my DCF I'll use a discount of 11%, growth of 10% over the next ten years, which is short of analysts expectations of 16%, and then 2% terminal after that, this gives me a value of $22.9 billion, add in cash of $3.8 billion and we get a value of $26.7 billion not much higher than today's market cap of 23.5 Billion, in fact only 9% higher and more than all of that is cash, not really much of a margin of safety.

In conclusion Best Buy may be relatively undervalued today, but slower prospective growth in coming years puts it at just around fair value when looking from a DCF perspective. My assumptions are conservative, though basically align with Morningstar who predicted one year of 16% growth before ten percent, I want companies to be at least 30% undervalued with conservative estimates, which bake in two layers of safety, before I decide to spend a lot of time researching it to find out where the value really is.

But, Best Buy is a good company, and a lot more experienced investor may be able to justify higher growth predictions, or may have found some hidden real estate value but my analysis says wait for it to fall about 10% before putting more work in.