Continuation from yesterday……..Yet, Best Buy’s story is best told by the number of stores they operate and the margin expansion the company was able to squeeze out of its existing stores. Leading into its 1997 stock price bottom, the company had increased its store count by 13% with a net addition of 33 new stores. As of December 31st, 1997 the company was operating 284 stores from coast to coast. At that time the rate of expansion was significantly slower than the previous three years when the company opened a total of 140 stores.
Further, at the time the company believed that it needed to slow down its store growth in order to re-focus on improving the company’s operating and financial performance. Planning to open just 25 new stores in fiscal 1999, bringing the store count to 309. In other words, prior to 1997, the company over expended its store base by growing too fast and by compressing margins in their existing stores. As a result, the company was going through a rough time. Forced to cut its new store growth and to find a new way to attract and to keep customers.
Hence the lower stock price. Between 1994 and 1997 Best Buy’s stock price declined by over 75%, dropping from $4.50 (split adjusted) to $1 a share. The company was going through a transition during the time. As was mentioned above it was forced to slow down its new store growth from about 47 in the years prior to 1997 to just 25 in 1999. Further, it was searching for a new store concept “Concept III” that would work and that would allow the company to expand their net operating profit margins. While being able to compete effectively in a cut throat business of electronics retail. Basically, by 1997 the future was anything but certain for Best Buy.
Yet, by 2006 the company was growing rapidly once again, with 822 stores under its belt. Increasing their store count by 290% between 1997 and 2006. The company was able to improve its operating margins from 2.2% in 1997 to 5.6% in 2006. Finally, the sales per retail square foot went from $720 in 1997 to $936 in 2006.
So, Best Buy’s fundamental performance during this time can be summarized in the following fashion.
- Best Buy’s stock price declined due to the margin compression and a slowdown in the new store growth. The company was going through a transitional period as it was trying to find a store concept that worked.
- The company was eventually successful in improving their concept and making it work. Leading to a substantial 150% improvement in their net operating margin.
- The company was then able to accelerate its new store growth, once again, increasing it by 290% over the next 9 years.
- Best Buy was able to cannibalize competition with their better concept and bigger stores, forcing a number of competitors, including Circuit City into bankruptcy (*2008).
When we combine the factors above we begin to understand why Best Buy’s stock was selling at a discount in 1997 and why it started to rally once the performance improved and the company began to grow at a rapid rate once again. Would investors be able to forecast such changes all the way back in 1997 from the fundamental perspective alone? Not really as the developments above took years to develop.
In addition, a few questions remain. While company’s initial undervaluation and subsequent growth can explain the first 1,000% to 2,000% increase in Best Buy’s stock price, it cannot explain why Best Buy’s stock price went up 4,000% during this period of time. Perhaps technical analysis can offer us a better answer.
To Be Continued On Monday
