Betting On Best Buy Over Amazon

| About: Best Buy (BBY)

Best Buy (NYSE:BBY) and Amazon (NASDAQ:AMZN) appear to be companies headed in different directions. While Amazon has seen steady revenue and earnings growth over the quarters and over the years, Best Buy's revenue has been flat, with its earnings actually declining.

But what makes a stock attractive is not simply the trajectory of the results of the underlying business. If this were the case, stock prices wouldn't matter, as a growing business would be a "buy" at any price. In the cases of Amazon and Best Buy, the stock price differences between these two companies have become so extreme that it has become highly likely that Best Buy stock will outperform that of Amazon in the coming quarters and years.

To see why this is so, consider what the investor in each of these two companies is getting for his investment dollar. A $1 investment in Amazon at today's price yields just one penny in earnings. On the other hand, a $1 investment in Best Buy today gives the investor a whopping (by comparison) fifteen cents in earnings.

Of course, those earnings are subject to change. But the difference in earnings yield is so large that even monumental events are unlikely to completely close this gap. For example, even if Amazon doubles its earnings somehow (which is extremely difficult to do; as it is, Amazon has required the last four years to manage that), the investor is still only receiving two cents for every dollar of investment. And that's only if things go really well!

On the other hand, the shareholder in Best Buy doesn't need anything dramatic to happen for him to make money. Even if the company's earnings decline in the coming years, he will likely do just fine. That fifteen cents is not being wasted on investments with uncertain returns; instead, it is being returned to him in the form of dividends and buybacks.

It's also important to recognize that humans are poor predictors. So while it may appear obvious to everyone that Amazon will take over Best Buy's market, it's far from a foregone conclusion. In fact, there are reasons to believe Amazon's advantage in the consumer market is eroding.

First, the tax advantage Amazon enjoys appears to be on the way out. New laws to take effect in California are likely to pave the way for an environment where both companies are on equal footing with regard to the taxes they have to charge consumers, narrowing the product pricing gap that exists between these two companies.

Second, Best Buy continues to improve its online offerings. Its recently introduced Marketplace allows 3rd party sellers to connect with buyers, with Best Buy retaining a sales commission. Best Buy is also increasing its online offerings over and above what it carries in store, further competing with Amazon.

Furthermore, Best Buy's distribution network remains an advantage against online retailers, as in-store pickup accounted for 40% of the company's online sales.

Finally, Best Buy is cutting costs, which should allow it to reduce prices further. A number of store leases are expiring in the coming years, and Best Buy should be able to reduce its square footage count while maintaining profits. (This is because mobile computing devices, the hot consumer items du jour, don't take up nearly as much space as the hot items of yesteryear, flat-screen tvs.)

There is no question that Amazon is a great company. But investors at the current price are getting ripped off, even if things go very well. For anyone with a time horizon measured in quarters and years rather than minutes and days, Amazon stock is extremely speculative. Best Buy stock, on the other hand, is a relative bargain, as it appears investors have overreacted to the downside. As such, it is very difficult to envision a scenario whereby Best Buy stockholders don't come out ahead in the long term, whatever unexpected may occur in the underlying businesses.

Disclosure: I am long BBY.