Searching for Value in Retail

 

“A robber who justified his theft by saying that he really helped his victims, by his spending giving a boost to retail trade, would find few converts; but when this theory is clothed in Keynesian equations and impressive references to the ‘multiplier effect,’ it unfortunately carries more conviction.” – Murray Rothbard, Austrian school economist, historian and political theorist

“Star Trek characters never go shopping.” – Douglas Coupland, Canadian novelist and artist

“I went to a bookstore and asked the saleswoman, ‘Where’s the self-help section?’ She said if she told me, it would defeat the purpose.” – George Carlin

“A bookstore is one of the many pieces of evidence we have that people are still thinking.” – Jerry Seinfeld

 

Pets.com – the short-lived e-commerce business that sold pet accessories and supplies direct to consumers over the internet – was launched in February 1999 and went from an IPO on a the Nasdaq Stock Market to liquidation in 268 days. The failed venture came to epitomise the excesses and hubris of the tech bubble.

Bernie Madoff and Lehman Brothers were the defining casualties of the Global Financial Crisis and Greece became the poster child of Europe’s sovereign debt crisis.

In any prolonged bull market signs of ‘irrational exuberance’ begin to emerge prior to the onset of the inevitable bear market. And it is not uncommon in such bull markets for many a market participant to begin pointing out specific areas of the market where excesses may exist well ahead of a crash. Very few, if any, market participants, however, are able to identify a priori the very companies and assets that come to define the bull market.

In the present iteration of the bull market investors and commentators have pointed out all sorts of potential ‘bubbles’ including but not limited to negative yielding developed market bonds, 100 year sovereign bond issues by emerging market nations, bitcoin ethereum ripple crypto currencies, Chinese credit, unlisted unicorns, Australian real estate, Canadian real estate, and FAANG stocks. While any one or all of these assets may come to define the animal spirits of this bull market, to us the US equity bull market of the past decade is best captured by the fortunes of two companies: Amazon ($AMZN) and Barnes & Noble ($BKS) – the disruptor and the disrupted.

Amazon versus Barnes Noble Price Performance (04 July, 2008 = 100)

BKS AMZNSource: Bloomberg

The price of $AMZN shares is 23 times higher than it was in July 2008, while the price of $BKS shares today is approximately 60 per cent lower than it was then.

The above chart captures within it the dominant trend of this US equity bull market: growth outperforming value. Consider the relative performance of S&P 500 Growth Index to that of the S&P 500 Value Index during this bull market: from the indices being almost even in July 2008, the growth index is almost 50 per cent higher than the value index today.

S&P Growth Index to S&P Value Index Ratio

SGX to SVXSource: Bloomberg

In fact, the ratio of the growth index to value index is at its highest level since June 2000 when the ratio peaked at the height of the tech bubble. This ratio is now less than 5 per cent from its tech bubble peak.

 

Investment Perspective

 

Value investors have had a rough ride over the last decade and despite the significant out performance of growth during this period it is arguably even more difficult to invest in value today than it has been at any point over the last ten years.  The struggles of value investors has led to many questioning the “value of value” and even one of its strongest proponents, David Einhorn of Greenlight Capital, to joke about it. Did not someone wise one once say “There’s a grain of truth in every joke”?

For the record, we do not think value investing is dead. We do acknowledge, however, that differentiating value from value traps has probably never been more difficult in the modern era than it is today. The sheer number of incumbent business models being disrupted means that for anyone, except the most insightful, it is only hubris that would allow one to have rock solid confidence in the durability of any incumbent business model.

With that being said and given that the ratio of the growth index to the value index is reaching record levels, we would be seriously remiss to not add a value tilt to our portfolio at this stage of the bull market. Our approach in making a value allocation within our portfolio is to add a basket of stocks that may collectively prove to have had value but the failure of one or two of the businesses do not permanently impair the portfolio. In this regard, we identify three retail stocks to add to our portfolio and will look to add more value candidates from other sectors to our portfolio over time.

 

Barnes & Noble $BKS

Trading at a price to consensus forward earnings of around 10x and with a market capitalisation of under US dollars 500 million, $BKS remains a potential target for even the smallest of activist investors or private equity funds.

$BKS has already initiated a turnaround plan which includes trialling five prototype stores this fiscal year. These stores will be approximately 14,000 square feet, making them roughly 40 per cent smaller than typical $BKS stores. The new format will be focused on books, and include a café as well as a curated assortment of non-book products including toys and games. Under performing categories like music and DVDs will be dropped.

Whether the turnaround can stop the bleeding or not remains to be seen but given where sentiment and valuation for the stock are, we think any signs of a turnaround in financial performance will be rewarded with a significant re-rating of the stock.

 

Bed, Bath & Beyond $BBBY

Trading at a price to consensus forward earnings of around 9x and with a market capitalisation of under US dollars 3 billion, $BBBY is also a viable target for activist investors or private equity funds.

$BBBY has also initiated a turnaround plan.

More importantly, however, millennials are gradually stepping into home ownership and the wave of home buying is only getting started. With increasing home ownership comes increasing consumption, new homeowners have to fill up their houses with everything from furniture to lawnmowers. The marginal dollar of conspicuous consumption will be spent on stuff. For the homeowners this will be household goods. For the non-homeowners this will be on clothes, shoes, sports equipment, and health and beauty products.

We think $BBBY could be a beneficiary of increased millennial home ownership.

 

GameStop $GME

The stock trades at a price to consensus forward earnings of less than 5x. $GME may ultimately fail but at such a low valuation and a dividend yield of around 10 per cent, if the business can simply manage to survive a few years longer than the market expects it to, it will turn out to be a very good investment.

 

We cautiously add $BKS, $BBBY and $GME to our long trade ideas.

 

This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

 

 

 

 

 

The Price of Growth

 

“To act wisely when the time for action comes, to wait patiently when it is time for repose, put man in accord with the tides. Ignorance of this law results in periods of unreasoning enthusiasm on the one hand, and depression on the other.”  – Helena Blavatsky, Russian esoteric philosopher, and author who co-founded the Theosophical Society in 1875

 

“Intelligence is the ability to adapt to change.” – Stephen Hawking

 

“As soon as you stop wanting something, you get it.” – Andy Warhol

 

One of the universally accepted ideas in sport is that of home court advantage. The idea, after all, is not a difficult one to accept: Home teams have the crowd behind them, cheering them on, filling them with confidence; visiting teams, on the other hand, have to deal with the home crowd’s hostility, which saps energy. And the stats seemingly reinforce the idea. For example, over the course of the NBA’s history, home teams have won roughly 60 per cent of the games played in almost any given season.

The crowd is powerful.

When it comes to capital markets, the crowd has unquestionably been cheering on growth and mocking value. Leaving many a value investor confounded by the apparently unstoppable rise in the likes of Netflix, Amazon, and NVIDIA. While valuations may be stretched and fundamentals in some cases appear questionable, if we take a step back and consider the secular trend, the continued outperformance of technology becomes less puzzling.

Plotting total business sales of US corporates against the ratio of Nasdaq 100 Index to the S&P 500 Index, we find a strong correlation – 74.1% using monthly data – between the two data series. That is the outperformance of the technology focused Nasdaq 100 Index relative to the broader S&P 500 Index is positively correlated with US business sales.

Total US Business Sales versus Nasdaq 100 Index to S&P 500 Index Ratio Business SalesSources: Federal Reserve Bank of St. Louis, Bloomberg

Given the latency between data releases, this relationship does not provide a trading signal. The relationship, however, does appear to suggest that US business sales growth has largely been dependent upon the growth in sales at technology companies and the market accordingly has rewarded technology stocks.

Our goal here is not to espouse the merits of investing in technology or in growth. Instead, we want to focus on what we consider to be the most interesting part of the above chart – the period from 2003 through 2006. During this period US business sales grew strongly yet the ratio between the two indices flat lined i.e. the S&P 500’s price performance roughly matched that of the NASDAQ 100.[i]

Digging a little deeper, we plot the ratio of per share sales of the S&P 500 to per share sales of the NASDAQ 100 against the relative price performance of the NASDAQ 100 Index to the S&P 500 Index. Zooming in on the period between 2003 and 2007 we find that the comparable price performance of the two indices during this period coincided with the quarterly fluctuations in per share sales also being comparable. Similarly, during the years of significant relative outperformance by the NASDAQ 100 Index, we find that per shares sales of the index were increasing relative to the per share sales of the S&P 500 Index.

Nasdaq 100 Index T12M Sales to S&P 500 Index T12M Ratio (Quarterly Data)Per Share RevenueSource: Bloomberg

Next, we consider the relative performance of S&P 500 Growth Index to that of the S&P 500 Value Index. Comparing the performance of these two indices we find that while the Nasdaq 100 Index and S&P 500 Index achieved comparable performance during the period from 2003 through 2006, the value index significantly outperformed the growth index during this period. The value index peaked relative to the growth index in 2007.

 

Ratio of S&P 500 Growth Index to S&P 500 Value Index (Monthly Data)growth to valueSource: Bloomberg

At the time of the dotcom bubble the ratio of the growth index to the value index, on a monthly basis, peaked at 1.56. Today the ratio stands at 1.47.

The crowd may well be at the cusp of switching loyalties.

We look for clues in and around the period between 2003 and 2007 to help us determine whether the time for value is coming or not.

The cyclical low in the effective US Federal Funds Rate registered a cyclical low in 2003.

US Federal Funds Effective RateFed funds rateSource: Bloomberg

The Commodity Research Bureau All Commodities Spot Index registered a cyclical low in 2001 and MSCI Emerging Markets Index started its multi-year ascent in 2003.

CRB Spot All Commodities IndexCRBSource: Bloomberg

MSCI Emerging Markets IndexMSCISource: Bloomberg

The US dollar had its cyclical peak in 2002, the same year in which the Bush Administration imposed tariffs on imported steel.

In 2004, Congress approved a one-time tax holiday for US corporations repatriating overseas profits.

In 2005, George Bush signed a USD 286 billion transportation bill.

If we compare the events and market action that preceded and coincided with the relative outperformance of value during the years from 2003 to 2007 to that of today, we find many similarities across both policy-making and market action. With growth’s outperformance relative to value reaching levels last seen during the very same period, the signs are difficult to ignore. It may not be time to bail on growth as yet, but it certainly is not the time to have a 100 per cent allocation to it either.

 

Investment Perspective

 

Human nature is such that we desire that which is rare and take for granted that which is common. In the recent past growth has been elusive – and that which has been available has been heavily concentrated in the US and in technology. It is no wonder then that investors have rushed into US technology names without abandon.

Growth is no longer as elusive. We can find growth in Asia, Europe and other parts of the emerging world and across both old industries and new. With its abundance the price of growth should de-rate. Value, however, has become hard to find and it is this scarcity of value, we believe, that will bring about the inevitable shift in market leadership away from technology to other sectors.

Forewarned is forearmed.   

 

[i] The total return for the NASDAQ 100 Index for the period was 80.9% versus 74.05% for the S&P 500 Index.

 

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This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.