- The Federal Reserve's loose money policies have enabled many weak firms to stay alive longer than they should have.
- Retailers have been one of the big beneficiaries.
- With QE winding down, it's time to be very discriminating when buying shares of retailers.
Quantitative easing -- the Federal Reserve's massive money-printing effort that began when the financial crisis hit more than five years ago -- hasn't had quite the impact on economic growth that many had hoped for, with the economy expanding at a fairly tepid rate over this past half-decade. But QE has certainly made an impact in a number of ways, some positive -- the stabilizing of the global financial system, for example -- and others, well, not-so-positive.
Bonnie Baha of DoubleLine Capital (the firm headed by bond guru Jeffrey Gundlach) recently pointed out one of the latter that has been overlooked -- what she terms "the walking dead" phenomenon. "I am referring to zombie credits -- seemingly healthy bonds issued by institutions with dubious economic net worth and unsustainable business models," Baha wrote in Forbes. "The animator of these corporate corpses is none other than the Federal Reserve and its quantitative easing program. … They represent unintended consequences of our central bank's QE program, which has essentially allowed the U.S. to defer, if not entirely skip, a normal default cycle in which troubled companies are culled from the marketplace."
Baha says that "no industry outside banking has benefited more from the Fed's largesse, and the yield hunger of investors, than retailers." She cites J.C. Penney and Sears as being among the "zombies." Both have "pretty junky" debt ratings, she says, "But the spigot is still open for them -- five-year loan obligations trade at a respectable 6.625% yield" thanks to QE.
While Baja manages a bond fund, the dangers of these types of companies certainly extend to stock investing as well. With the Fed tapering its QE program, financially unsound companies that have benefited from the easy money environment could be facing a shock over the coming months and years. That doesn't mean you should categorically avoid retailers; what it means is that you should be very discriminating in which retail stocks you buy.
Given that, I recently looked for retailers that get approval from my Guru Strategies, investment models based on the approaches of Warren Buffett and other highly successful investors, and which have very low debt levels. I made sure each stock has a current ratio (current assets/current liabilities) of at least 2.0, and more net current assets than long-term debt -- two criteria used by the model I base on the great Benjamin Graham's "Defensive Investor" approach. Here are a handful that make the grade.
Bed Bath & Beyond Inc. (NASDAQ:BBBY): This New Jersey-based home goods and furnishings retailer ($12 billion market cap) has stores in the U.S., Canada, and Mexico, and has taken in about $11.5 billion in sales in the past 12 months. It has no long-term debt and a current ratio of 2.1.
Bed Bath & Beyond gets strong interest from my Peter Lynch-based model. Lynch famously used the P/E-to-Growth ratio to find bargain-priced growth stocks, and when we divide the firm's 12.7 price/earnings ratio by its 20% long-term growth rate (I use an average of the 3-, 4-, and 5-year earnings per share growth rates to determine a long-term rate) we get a PEG of just 0.64. That easily comes in under the model's 1.0 upper limit. The Lynch-based model also likes the company's lack of any long-term debt.
The Buckle (NYSE:BKE): This Nebraska-based retailer of casual apparel, footwear and accessories for men and women has more than 450 stores across most of the US. It has no long-term debt and a 2.8 current ratio.
The Buckle ($2.2-billion-dollar-market-cap) gets strong interest from my Joel Greenblatt-inspired model. Greenblatt's remarkably simple approach looks only at the return a company generates on its capital, and at the firm's earnings yield (which is similar, but not identical to, the inverse of its price/earnings ratio). The Buckle's earnings yield is a bargain-priced 12.4%, while its return on capital is a stellar 61%. That makes it the 21st-most-attractive stock in the market right now, according to this model.
Foot Locker (NYSE:FL): This specialty athletic retailer operates nearly 3,500 stores in North America, Europe, Australia, and New Zealand, offering athletic footwear and apparel. It has a 3.8 current ratio and just $136.0 million in long-term debt vs. net current assets of $1.7 billion.
Foot Locker ($6.9 billion market cap) gets strong interest from my James O'Shaughnessy-based model. When looking for growth stocks, this model looks for stocks that have upped EPS in each year of the past half-decade, which Foot Locker has done. It also looks for a key combination: a high relative strength, which is a sign the stock is being embraced by the market, and a low price/sales ratio, which is a sign it hasn't gotten overpriced. With a 12-month RS of 73 and a price/sales ratio of 1.1, Foot Locker makes the grade.
Hibbett Sports (NASDAQ:HIBB): Alabama-based Hibbett is a sporting goods retailer focused on small and mid-sized markets, with about 850 retail stores across 26 states. The $1.4-billion-market-cap firm has a 3.5 current ratio and long-term debt of just $2.9 million vs. net current assets of $232.2 million.
Hibbett is a favorite of my Warren Buffett-inspired model. It likes that the firm has increased EPS in all but two years of the past decade, has very low debt, and has a 10-year average return on equity of 23.7%. My Lynch-based model also likes Hibbett, thanks to its 21.7% long-term growth rate, low debt and 0.94 PEG ratio.
Tractor Supply Company (NASDAQ:TSCO): This Tennessee-based mid-cap is the largest retail operator of rural lifestyle stores in the U.S. -- think Home Depot geared toward farmers. It has a 2.1 current ratio and $81.2 million in long-term debt vs. net current assets of $694.7 million.
Tractor Supply ($9 billion market cap) is another favorite of my Lynch- and Buffett-based models. The Buffett approach likes that it has upped EPS every year of the past decade, has very reasonable debt, and has a 10-year return on retained earnings of 20.0%. The Lynch approach, meanwhile, likes its 27.7% long-term growth rate, low debt, and 0.99 PEG, which just makes it under the model's 1.0 upper limit.