Sunday, September 16, 2007

The Trouble With Best Buy (BBY)

To answer this question, one must simply look at the "competitors" tab on Yahoo Finance.

I am a true believer that a companies stock price will increase as it produces real returns earned from sales and investments. In addition, if I buy a company, I must have a reasonable understanding of their business and future projections. I know and understand Best Buy, and I love their stores and product assortment. However, I feel there are signs of trouble ahead.

I was Best Buy's (BBY) biggest advocate a few years back. The technology sector was booming, and Best Buy served as a medium of exchange for many new products, offering good quality items at low prices. However, even though the financials look great on paper, the market continues to weigh future returns, which is up for discussion among many brokers and investors.

They are profitable, with continued growth expected (PEG ratio of .95), P/E of 16.22, and a very clean balance sheet with plenty of cash. However, in my opinion, there is one major problem--Wal-Mart.

Wal-Mart continues to increase their technology product lines, carrying most, if not all the products Best Buy carries. The problem is that Wal-Mart carries most of the same products while undercutting Best Buys pricing. Best Buy offers discounted products, but Wal-Mart offers deep discounted products, which could be a major problem in the future.

Although Best Buy is a $20.8 billion company, Wal-Mart is a $177 billion company, and largely controls pricing power in the United States. In addition, Wal-Mart operates at extremely thin margins, which they can do because of their incredible volume and scale. However, Best Buy is small relative to Wal-Mart, and yet their company has operating margins of 5.31%, while Wal-Mart sits at 5.80%.

Even though Best Buy's growth expectations are better on paper than Wal-Mart's, I am scared to think what may happen if Wal-Mart engages in a price war.

I own shares of Best Buy, and the stock may hit $60 a share by years end. However, if earnings fall short of growth expectations, I would expect the stock to continue to lag the market, as evidenced by its flat stock price over the past year.

Recommendation: do not buy shares of Best Buy (BBY)

I am currently long Best Buy

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