108% Year-To-Date Gain at Best Buy Catch Your Eye? Read This First

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Shares of Best Buy (BBY), a company investors left for dead barely three months ago, are undergoing a resurrection of near miraculous proportions. At least nine industry analysts have joined a lone supporter with buy recommendations this year, and that has helped propel the share price to more than double December levels, as seen in a stock chart. But is there really a good reason to invest here now? Or are we looking at one of those lame and ultimately disappointing excuses for optimism that have tricked Best Buy investors so many times before?

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BBY Chart

The last spike in the share price is typical of market reaction to good news from Best Buy lately. The shares rose 16% after Best Buy’s announced plans to open 1,400 Samsung boutiques inside its stores to sell smartphones, tablets, cameras, televisions and other Samsung electronics. Investors love the idea because profit margins on these items are far better than on, say DVDs and laptop cases. It’s also a chance to get in on Apple-like stores, with their huge profit margins, in a brand that’s growing faster than Apple (AAPL) now. But a 16% share price gain for collecting these largely existing products into boutiques? The question here isn’t whether investors should be happy about the news; it’s whether their enthusiasm is out of proportion to events on the ground.

Best Buy’s March 1 earnings (actually, loss) report provided a similar boost to its share price. The results were better than expected, which was a welcome change from the two previous quarter reports that disappointed mightily, and they offered evidence of progress in the company’s turnaround plan. Best Buy closed 49 big box stores in the last fiscal year and will shutter between 5 and 10 more this year, which the company expects will save it about $800 million by 2015. The closings helped drastically cut expenses last year.

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BBY SG&A Expense TTM Chart

Profit margins also showed unexpected resilience for a store desperate for customers to buy more. A guarantee to match competitor prices didn’t do as much damage to profit margins as some feared. This is important because Best Buy is maintaining that offer as a way to keep customers standing in its own showrooms from making their actual purchases on Amazon.com (AMZN). Same store sales were actually up slightly, although it’s hard to peg how much a role price promises played.

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BBY Gross Profit Margin TTM Chart

Best Buy’s profits were declining even before revenues began to fall off in 2011, and its share price dropped some 67% between 2010 and the end of 2012. Whether these moves can lessen the underlying cause of that decline – competitive weakness – is yet to be seen. Amazon, Target (TGT), Wal-Mart Stores (WMT), Apple and a whole rash of smaller competitors are still around to suck away its customers.

Best Buy investors have prematurely bet on a turnaround before. A lot of those bumps in the 5-year share price chart represent investor anticipation of nice earnings reports that disappointed instead.

Best Buy shares now trade at a forward PE ratio of about 11.5. That’s cheaper, although closer than one might have thought, to the 14.6 and 14.1 PE ratios of Wal-Mart and Target, respectively. It’s also as expensive as a Best Buy share has been since 2010. Really, though, the Best Buy valuation is a little suspect given that the company is offering no guidance for its current year earnings. That PE is based solely on outsiders’ estimates. And outsiders have a long history of overestimating what Best Buy can really do.

Dee Gill, a senior contributing editor at YCharts, is a former foreign correspondent for AP-Dow Jones News in London, where she covered the U.K. equities market and economic indicators. She has written for The New York Times, The Wall Street Journal, The Economist and Time magazine. She can be reached at editor@ycharts.com.


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