Here's a quick exercise that I find quite interesting:
Assume that you are looking at a company in 2005 with the
following characteristics: it reported revenue of just over $39.5
billion, and net income of $1.07 billion (net margin of 2.7%);
now fast forward to 2011, and look at that same company in the
heart of a global economic slowdown - sales for the fiscal year
came in at $43.6 billion (1.66% CAGR) and net income was up
slightly to $1.12 billion (net margin of 2.6%).
You know that this company has been hurt by unemployment (and
that key markets are materially worse off in this metric compared
to the starting period), but expect that an eventual recovery in
certain markets around the globe will act as a tailwind for the
business. As far as headwinds go, the company is facing some
structural changes and intensified competition, though not from
anyone beyond competitors that were ferociously fighting for
share in 2005 as well.
With this information, what would you be willing to say about the
relative value of this corporation - more attractive in 2005,
more attractive in 2011, or just about the same in both periods?
In reality, this isn't a single company - it's the collective
results of the three main U.S. office supply chains: Staples (
SPLS
), Office Max (
OMX
), and Office Depot (
ODP
). Looking at the results for both years, I would assume the
consensus is that while the slight contraction in net margin is
concerning, the ability to continue driving sales growth (albeit
slowly) in the heart of the worst economic crisis since the Great
Depression is a plus; as a result, I would conclude that there's
little to suggest that intrinsic value has moved materially in
either direction.
The market, on the other hand, doesn't seem to agree: in 2005,
these companies had a collective market capitalization of $25
billion; Mr. Market was willing to pay 24x earnings for a company
facing structural headwinds (the negative impact of computers,
email, etc on paper and ink sales was widely anticipated) and
intensifying competition from a growing e-commerce industry. Fast
forward six years (and into the heart of double digit
unemployment around the globe), and it appears that the industry
has (collectively) navigated this environment with some success -
except now Mr. Market is only willing to pay $8.4 billion, or
one-third of the previous amount, for a comparable level of
earnings.
This isn't to conclude that these companies are currently
undervalued; all I'm trying to do is point out something that is
often overlooked - the threats facing these companies are
identical to what they were half a decade ago. Some people
believe that this industry is all but dead, that it will not be
able to stand up to Wal-Mart (
WMT
) and Amazon (
AMZN
) - and they point to a stock price that forecasts disappearing
earnings and other troubles ahead as evidence; personally, I
think using stock prices as justification for such beliefs rather
than the financials (which suggest something quite different) is
illogical (particularly if one is active in the markets, and thus
by deduction believes inefficiencies do exist).
My point is this: the market was willing to pay a rich premium
during the heights on an economic boom (essentially implying that
the good times would continue), yet will pay just a third of the
previous price for the same dollar amount of earnings in the
depths of a recession (essentially implying that the bad times
will not only continue, but intensify); for the individual that
can keep a level head while others are dancing between bouts of
euphoria and despair, I think the fundamentals point to a sweet
spot somewhere in the middle.About GuruFocus: GuruFocus.com
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