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Edward Lampert is the founder of ESL Investments Inc, a private investment company. He is also chairman of Sears Holdings Corporation (NASDAQ:SHLD). Since starting ESL Investments in 1988 at the age of 25, he has generated an annualized return averaging 29% a year. Like Warren Buffett, he targets mature and easily understandable businesses that have strong cash flows, with a focus on a company's ability to generate large amounts of cash over the long term. However, unlike Buffett, Lampert is less focused on the management team of potential targets as he is a very active investor who is willing to implement changes in the companies in which he has invested. For some time Lampert has been quite bullish on the retail sector and has built up significant experience investing in this sector. He regularly targets retail companies where he believes that he can pressure management into making changes that unlock shareholder value. In this article I will analyze five stocks that Lampert has recently purchased with a view to determining whether they have the potential to continue growing in value and if they have been undervalued by the market.

Big Lots Inc (NYSE:BIG)

Big Lots has a market cap of $2.57 billion, and is currently trading at around $39, with a price-to-earnings ratio of 13.53. Its 52-week trading range has been between $27.82 and $44.44. It reported third-quarter 2011 earnings of $1.17 billion a decrease from second-quarter earnings of $1.23 billion. The income statement showed net income in the third quarter of $35.68 million, a significant decrease from second-quarter net income of $52.47 million. It has quarterly revenue growth of 2.20% and a return on equity of 25%.

One of Big Lots' competitors is Dollar General Corporation (NYSE:DG). Dollar General has a market cap of $13.56 billion and is trading at around $40. It has a price-to-earnings ratio of 20.90, quarterly revenue growth of 11.2% and a return on equity of 16.23%. This indicates that both companies are performing on par.

Edward Lampert holds 1,877,168 shares of Big Lots, buying 577,063 shares in the third quarter 2011, adding to the 1,300,105 shares purchased in the second quarter. The average purchase price per share was $36.39. Based upon the last trading price of $39.13, he has made a return of 7.5%.

Big Lots' cash position has worsened in the last quarter. Its balance sheet showed $57.83 million in cash for the third quarter, a substantial decrease from $283.90 million cash in the second quarter. Big Lots' quarterly revenue growth of 2.2%, versus an industry average of 6.9%, and a return on equity of 25%, versus an industry average of 22.2%, indicates that it is underperforming many of its competitors from a growth perspective but has sound management that is generating a solid return from shareholder equity.

The outlook for discount variety stores is quite positive despite the poor economic outlook, high unemployment and negative consumer sentiment. Much of this outlook can be attributed to variety stores being able to capitalize on the recession, with more consumers turning to its stores for deep discounts. Over the next five years, dollar and variety stores are expected to perform well by targeting low-income households and thrifty customers.

Big Lots operates at the discount end of the retail sector, which, as discussed above, will experience growth in poor economic times as consumers seek to decrease expenditure by seeking out discounted goods. However, the earnings potential of companies generating revenue from the retail sector, remains poor in the short term, due to the poor economic climate.

When this is taken into account in conjunction with the negative industry outlook, its poor performance indicators decreasing net income and cash holdings, I prefer to take a wait and see approach. Accordingly I do not agree with Lampert’s decision to purchase a stake in the company and rate Big Lots as a hold.

Seagate Technology (NASDAQ:STX)

Seagate has a market cap of $6.77 billion, and is currently trading at around $16, with a price-to-earnings ratio of 14.73. Its 52-week trading range is between $9.05 and $18.60. It reported third-quarter 2011 earnings of $2.86 billion an increase from second-quarter earnings of $2.69 billion. Third-quarter net income was reported at $119 million, an increase from second-quarter net income of $93.00 million. It has quarterly revenue growth of 4.2%, a return on equity of 18.77% and pays a dividend with a yield of 4.1%.

One of Seagate’s competitors is Western Digital Corporation (NASDAQ:WDC). Western Digital has a market cap of $6.09 billion and is trading at around $26. It has a price-to-earnings ratio of 7.98, quarterly revenue growth of 12.4% and a return on equity of 8.8%. Based on these indicators it appears to be slightly outperforming Seagate Technology.

Lampert holds 10,478,723 shares of Seagate, buying 2,524,720 shares in the third quarter 2011, adding to an existing holding of 7,204,498. The average purchase price per share was $13.77. Based upon the last trading price of $16, he has made a return of 16.19%.

Seagate’s cash position has declined with $2.56 billion in cash for the third quarter 2011, an increase from $2.78 billion cash in the second quarter. The net tangible assets have slightly decreased to $2.43 billion in the third quarter from $2.46 billion in the second quarter. Seagate’s quarterly revenue growth of 4.2%, versus an industry average of 18.6%, and a return on equity of 18.77%, versus an industry average of 12.6%, indicates that it is outperforming many of its competitors.

The current outlook for the data storage device industry is negative primarily due to the poor economy. The economy's effect on business processes and new technology innovation will dominate the IT and data storage landscape, leading to a drop in demand as businesses focus on cost cutting and capital efficiencies to maintain profit margins.

Despite the negative industry outlook Seagate is a solid investment opportunity due to its strong performance indicators, increased quarterly net income and balance sheet cash. Accordingly, I agree with Lampert’s decision to invest in the company and rate Seagate a buy.

Gap Inc (NYSE:GPS)

Gap has a market cap of $9.58 billion, and is currently trading at around 19, with a price-to-earnings ratio of 10.24. Its 52-week trading range has been between $15.08 and $23.73. Third-quarter 2011 earnings of $3.39 billion were reported, an increase from second-quarter earnings of $3.29 billion. Third-quarter net income was $189.00 million, a decrease from second-quarter net income of $233.00 million. It has quarterly revenue growth of 2.1%, a return on equity of 29.26% and pays a dividend with a yield of 2.3%.

One of Gap’s competitors is American Eagle Outfitters Inc (NYSE:AEO), which has a market cap of $2.65 billion and is trading at around $14. It has a price-to-earnings ratio of 16.06, quarterly-revenue growth of 3.7%, a return on equity of 12.26% and pays a dividend with a yield of 3.2%. Based on this data both companies are approximately performing on par.

Lampert holds 36,286,240 shares of Gap, buying 5,925,848 shares in the third quarter 2011, adding to an existing holding of 30,360,392 shares. The average purchase price per share was $20.52. Based upon the last trading price of $18.76, he has made a return of -8.58%.

Gap’s cash position has declined with the balance sheet showing $2.10 billion in cash for the third quarter, a decrease from $2.42 billion in the second quarter. The net tangible assets have decreased with $3.12 billion in the third quarter 2011 from $3.77 billion in the second quarter. Gap’s quarterly revenue growth of 2.1%, versus an industry average of 4.1%, and a return on equity of 29.26%, versus an industry average of 19.40%, indicates that it is underperforming many of its competitors with regard to earnings growth but has sound management that is deriving solid value from shareholder equity.

The earnings outlook for the apparel industry is felt to be quite negative primarily due to the poor US economy and high unemployment, which has generated considerable negative consumer sentiment. However, there is some potential for improvement as some positive indicators have been reported regarding the performance of the US economy, which may help to lift earnings performance in the sector.

When considering the outlook in conjunction with company’s decreased net income and cash holdings coupled with a poor quarterly earnings growth rate it is difficult to justify any investment in the company. On this basis I do not agree with Lampert’s investment and prefer to take a wait-and-see approach with Gap. Accordingly, I rate the company a hold.

CIT Group Inc (NYSE:CIT)

CIT Group has a market cap of $6.38 billion, and is currently trading at around $32, with a price-to-earnings ratio of 81.28. Its 52-week trading range is $27.68 to $49.57. It reported third-quarter 2011 earnings of $1.15 billion, a decrease from second-quarter earnings of $1.26 billion. Third-quarter net income was -$16.30 million, a significant increase from second-quarter net income of -$48 million. It has quarterly revenue growth of -19.5% and a return on equity of 0.9%.

One of CIT Group’s competitors is Orix Corp (NYSE:IX). Orix has a market cap of $8.87 billion and last traded at around $41. It has quarterly revenue growth of -0.7%, a return on equity of 5.77% and a price-to-earnings ratio of 10.41. It pays a dividend with a yield of 2.2%. Based on these indicators is outperforming CIT Group.

Lampert holds 2,210,756 shares of CIT Group, buying 403,680 shares in the third quarter 2011, to add to an existing holding of 5,369,785 shares. The average purchase price per share was $41.97. Based upon the last trading price of $31.68, he has made a return of -24.52%.

CIT Group’s cash position has declined. The balance sheet showed $7.61 billion in cash for the third quarter 2011, a decrease from $10.34 billion in the second quarter. The net tangible assets have marginally declined to $8.90 billion in third-quarter 2011, from $8.59 billion in the second quarter. CIT Group’s quarterly revenue growth of -19.5%, versus an industry average of 14.4%, and a return on equity of 0.9%, versus an industry average of 6.4%, indicates that it is underperforming many of its competitors.

The outlook for the mortgage investment industry is at this time quite poor primarily due to the poor economy, high unemployment and tight credit markets, all of which are having a direct impact on demand.

On the basis of the poor industry outlook, CIT Group's net loss and declining cash holdings, I do not believe the company is a good investment. I believe there are better investment opportunities in the sector such as Orix and do not agree with Lampert’s decision to invest in CIT Group. Accordingly, I rate the company a sell.

iStar Financial Inc (SFI)

iStar has a market cap of $521.40 million, and is currently trading at around $6, with no price-to-earnings ratio. Its 52-week trading range has been between $4.51 and $10.48. It reported third-quarter 2011 earnings of $104.97 million, a significant decrease from second-quarter earnings of $147.60 million. Third-quarter net income was -$62.23 million, a large decrease from second-quarter net income of -$35.52 million. It has a return on equity of -4.47%.

One of iStar’s competitors is Capstead Mortgage Corp (NYSE:CMO), which has a market cap of $1.05 billion and is currently trading at around $12, with a price-to-earnings ratio of 7.15. It has quarterly revenue growth of 66.2%, a return on equity of 13.39% and pays a dividend with a yield of 14.2%. Based on these indicators, Capstead Mortgage is outperforming iStar.

Lampert holds 1,916,826 shares of iStar, buying the entire holding in third quarter 2011. The average purchase price per share was $6.86. Based on the last trading price of $6.25, he has made a return of -8.89%.

iStar’s cash position has improved in the last quarter. The balance sheet showed $256.33 million in cash for the third quarter 2011, an increase from $454.24 million in the second quarter. iStar doesn’t have a quarterly revenue growth rate, versus an industry average of 20.60%, and a return on equity of -4.47%, versus an industry average of 9.1%, indicates that it is underperforming many of its competitors.

The earnings outlook for the REIT industry is positive despite the challenging economic conditions and market uncertainty. Overall the industry is seen as an attractive investment because REITs generate income, an attractive dividend yield as well as the fact that they own hard assets. However, there is some concern regarding REITs that invest in property in the retail sector as the retail industry has been hit hard by the poor economic climate, high unemployment and negative consumer sentiment. This means that earnings for the retail industry are declining, affecting revenue and net income, thus affecting their ability to pay rents or expand. This has seen an increase in the vacancy rates for commercial retail centers, which will have a flow-on impact on revenue for REITs invested in retail property.

Despite the positive industry outlook, I do not agree with Lampert’s decision to invest in iStar, primarily as it has recorded a larger net loss than the last quarter and has less than impressive performance indicators. On this basis I believe there are far better investment opportunities in the REIT industry and rate the company a sell.

Source: 5 New Edward Lampert Buy Ideas