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Summary I am a cheapskate – I like a good bargain on quality merchandise. The same principle should apply to investing – why pay premium prices if we don’t need to? It is helpful to keep an eye on the value of something – since the price we pay is completely our choice, we know we got a good deal. This article provides two midcap examples where valuation mattered: those who ignored the price-to- value relationship were probably disappointed. As someone always looking for a bargain, I offer an example of a company possibly on the sale rack right now. I will confess: I am a cheapskate. There are many of us out there. For whatever reason, we like to get the best deal possible when we buy something. Name-brand clothing? Wait for a sale (“Can you believe it – $95 bluejeans for $56!”) Toothpaste and toiletries? Stock up during the in-store sales. Quality electronics? Wait patiently for holiday sales. Estate auctions are prime hunting grounds for us cheapskates. Imagine you are at a poorly-attended auction and a name-brand, 8-seat, mint-condition oak dining room table set has no buyers above $8.75 (this really happened). Even if we are not the buyer, we know that is probably a great deal. What makes it a “great deal” to us cheapskates? We know the value of something. Then we compare the price to that value. One of the subtle nuances of value investing is to apply that same mentality and behavior to our investment choices. This is often easier said than done, because investing can seem to turn things upside down: rather than wanting lower prices, we like it when prices go up. And we may not be confident in our ability to value a company. In my view, we would become better investors if we continually explore and understand this whole price-to valuation relationship. Why? Mr. Buffett, as usual, says it well: “The critical investment factor is determining the intrinsic value of a business and paying a fair or bargain price.” Objective The point of this article is to suggest that we can and should apply our same frugal mentality to our investing decisions. And this discussion assumes that historical facts on any company could serve as one piece of our investing decision-making. To support that view, two midcap companies will be offered as examples where valuation mattered over time–those who bought well above normal valuations were disappointed, and those who acted when the price fell below valuation were rewarded. Lastly I will offer an example of a company likely on the discount rack at current levels. Valuation Matters, Example 1: CEB, Inc. $2.5 billion company CEB Inc., provides ”best practices” research and analysis, focusing on corporate strategy, operations, and human resources issues. With a long-term, normal PE around 37, it is never really cheap by absolute standards. But a closer look at the company’s own history gives us a good guide toward periods where the price seemed overvalued or undervalued. Have a look at the graph below, courtesy of my F.A.S.T. Graphs subscription. Please note the orange line represents a valuation tied to the earnings per share growth rate. And also note that the blue line represents the company’s own PE over time. The black line is the market price line. You’ll see the period from 2006 to 2009 highlighted first. Note that investors who bought when the PE was well above the company’s own norms were in for sharp disappointment until the bottom in 2009. From a price to valuation perspective, in 2006 as CEB was running well above its own historical norms. In addition, a year-by-year review of high and low PE’s the company actually experienced would suggest that shares were not on sale around that time. If viewing investment decisions from a frugal, “cheapskate” perspective, the period of overvaluation would not have been enticing to bargain hunters. (click to enlarge) Historical Graph – Copyright 2015, F.A.S.T. Graphs – All Rights Reserved The picture in 2009-2010 following the Great Recession was a different story. In that period CEB was offered at a discount to its normalized valuation. Thrifty buyers paying attention to valuation may likely have recognized this period as an opportunity to buy as part of a “storewide sale” in the stock-market. Investors at that time have probably been satisfied with the purchase. (click to enlarge) Historical Graph – Copyright 2015, F.A.S.T. Graphs – All Rights Reserved Valuation Matters, Example 2: Brown & Brown, Inc. (NYSE: BRO ) $4.5B company Brown & Brown, Inc. ( BRO ) offers another example where the price to valuation situation mattered to investors. Brown & Brown operates an insurance brokerage firm that markets property/casualty products and services to commercial,professional, and individual customers. F.A.S.T. Graphs again offers a useful picture. Note in this example the orange line represents a possible valuation based on an earnings multiple of 15X, the blue line is the company normalized PE ratio over time, and the black line is the market price. Please take a look at the period beginning in 2006. In that period, we bargain-hunters would notice that the PE ratio was well above norms for this company. Those who bought near those peak levels had to watch the decline during the Great Recession and thereafter and didn’t experience a bottom until 4 years later. While in this case even those who bought in 2004 or so would have been impacted, an eye on excessive valuations may have limited the damage to those buyers. (click to enlarge) Historical Graph – Copyright 2015, F.A.S.T. Graphs – All Rights Reserved Fast forward to 2011 when it again appeared BRO was being offered at discount levels. The PE had sold off to well below historical norms and yet earnings forecasts for this quality company were intact. Those willing to wait for sale prices have probably been satisfied with the returns since that time. (click to enlarge) A Company Possibly On Sale: Bed, Bath & Beyond (NASDAQ: BBBY ) The previous two examples were offered as examples where a look at relative valuation to price may have been helpful. But those were looks at history. Looking forward and applying the cheapskate mentality, it is possible that BBBY is on the discount rack right now. At around $57 BBBY is near its 52-week lows and has been sold off to a point where it merits close review. First, Let’s Make Sure BBBY is Quality Merchandise The idea is to buy quality merchandise on sale, not the low-quality stuff. In my view, BBBY qualifies as a quality company based on, among other factors, its historical growth in per share book value, earnings, and revenue. This F.A.S.T. Graphs snapshot captures the trend graphically: (click to enlarge) Historical Graph – Copyright 2015, F.A.S.T. Graphs – All Rights Reserved Why Are Shares On Sale? BBBY sales have been a bit slower than desired, and the retail environment has been challenging. That and the entire retail sector has seen selling lately. The company itself, however, is taking steps to increase sales and has authorized a share buyback program which is favorable. Here’s Where Valuation Matters Again a F.A.S.T. Graphs summary is a useful tool. My read is that BBBY has done a very effective job of growing earnings and valuation over time (orange line). Recall the blue line represents a normal PE and the black line is price. Over a 20-year time frame the normal PE for this company is 23.6X. And note there have been times (2002-2004) when the company is actually priced at a premium and not as attractive to us frugal types. But the situation today is different: the current PE is around 12X earnings. At these levels, with solid fundamentals and earnings expected to grow, this appears to be a case where the price is now attractive. This is visible when viewing the relationship between the price I pay (which I can control) and the valuation – which includes lots of external forces I cannot control. Interestingly, as a side note, I suspect the recent range-bound price action means there is uncertainty in the market. As a patient investor, that’s no worry as long as I am confident in the quality of the merchandise: I realize I sometimes need to wait for the value to be recognized later. (click to enlarge) Historical Graph – Copyright 2015, F.A.S.T. Graphs – All Rights Reserved Recap I have noticed that it is fairly easy being a cheapskate for day-to-day life purchases: waiting for a good sale or refusing to purchase something at unreasonable prices comes fairly easily when it comes consumer goods or even larger purchases like cars and homes. It seems easier to recognize value. But often that mentality gets turned upside down when investing. The focus is price – and we always want that price to go up. The point of this article was to suggest that we can and should apply our same frugal mentality to our investing decisions. To support that view, two midcap companies were offered as examples where valuation mattered over time–those who bought well above normal valuations were disappointed, and those who acted when the price fell below valuation were rewarded. Lastly I tried to outline why and how BBBY may be a company likely on the discount rack at current levels. To a cheapskate like me, that is music to my ears. As always, thank you very much for reading. All of this is in my opinion only and intended solely to add to the investing conversation so that we all benefit. Scalper1 News
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