Big Five Sporting Goods Fundamental Analysis

As I mentioned in this blog's investment thesis, I believe fundamental analysis can work for long term stock picking of companies that are cash flow generators and valuation targets. This entry is the first one I have done concerning fundamentals since GMR.

Big Five Sporting Goods is a stock I used to follow in a previous life as a buy side analyst. On top of meetings with management I visited their very impressive state of the art distribution center. This kind of due diligence work can help prevent the small chance of a fraudulent company, or help you preemptively find those "something's not right" moments. However, this company seems rock solid and one that I am looking at from a longer term fundamental buy position.

I have done some deeper analysis, but attached I have 4 simple summaries of how to value a company fundamentally. The first picture shows the financials of the past year and a half and some simple valuation metrics in the bottom.



As can be seen, the company creates around $0.45 per share in free cash flow, which theoretically could all be paid out to shareholders as dividends. Another valuation metric is Price to book value. Anything that is 1 or below means that the company is currently valued at its liquidation price...so if the company had to liquidate everything in a desperate moment, this is likely the price it would get. However, this is rare and typically a worse case scenario valuation. Most companies trade above 1.0 book value.

The next excel screenshot shows what the company could be worth to a private equity company or other buyer. Typically public companies cost more because of the public "premium" that the markets create. Assuming a 7.0x EBITDA valuation is likely conservative.





The next photo shows a simple discounted cash flow model with a Gross PP&E terminal value discounted to today's assumed price. One scenario assumes zero growth and the other assumes a 10% growth. Typically DCF models are conservative in that they assume a longer time horizon for an event to occur, which makes the discounted value of that event worth less (in this case a 10 year horizon generating only $3.42 in current value - note that if the event was moved up to year 5 then the terminal value would create $6.00 of present value). I have assumed a 12% discount rate which is likely conservative given the current market and low interest rate environment.





Averaging all of these valuation methods together, comes up with an $11.10 price which is significantly higher than the current $6.88 price. Alternatively, the lowest and most conservative valuation yields a $5.96 price which should provide a decent floor for the stock price.

The risks include the Free Cash Flow falling and/or the values of PP&E and Inventory on the books are overstated. However, The conservative case takes most of this into account by assuming no FCF growth in the next 10 years as well as an event that doesn't occur for another 10 years.

My experience with Big Five, its ownership, and management are the intangibles that add peace of mind to my thesis that Big Five Sporting Goods is likely undervalued at these prices and constitutes a "buy".

Good Luck

The S&P Currency Ratio Charts

After my posting yesterday I was thinking again about how much currency affects stock prices (answer: a great deal much!). To prove the effect, I came up with the attached chart which measures the performance since the October 2007 top of the S&P500 as well as its performance based in other marketable goods other than the US Dollar. The way to think about the chart is the conventional S&P 500 measurement is 1 S&P500 priced in $1 US Dollar or $SPX/$1. But, you can swap out the denominator in the equation to compare the $SPX in other liquid assets such as 1 canadian dollar, or one euro, or one barrel of oil, etc.

The reason this is relevant is because the markets are global. People from all over the world invest in the United States and vice versa. As such, people like me in the United States are affected by currency fluctuations. As a net importer most of the products purchased are from other countries (oil, electronics, many others). The exchange rate affects us more than we likely even know as a result. A truly localized economy wouldn't be affected by such things and would have a rather constant exchange rate, but that just isn't the world we live in.

In the attached chart I show the S&P500 in solid blue which is the S&P chart most people are familiar with. However, all the other line charts are also the S&P500! But, how can that be?!?!?!



The difference between the blue line and the 5 others is the blue line is the S&P500 as measured in US Dollars, the typical view found everywhere. The dashed lines are the S&P500 measured in other currencies (Red=Euro, Pink=Yen, Purple=Canada), an atypical view rarely if ever viewed or talked about. The thin black line is the market priced in a barrel of Oil and the Gold line is the market priced in an ounce of Gold. As you can see there are some major differences in price when the measurement tool is swapped out.

From a currency standpoint, the market priced in Yen (purple dashed) is only up about 20% since the March 2009 $730 equivalent level. Compare this to the S&P in dollars (blue line) which is up over 50% since then and sits at over $1200. The S&P/1 Canadian Dollar is fairing a little better, but still below the US Dollar priced S&P. The Euro is most similar to the USD based S&P, just slightly below, which means the Euro since then has behaved similarly to the US Dollar.

The S&P priced in oil is the outlyer of the group with wild swings. From the October 2007 high, the S&P priced in Oil is also lower at around $1075 from $1350...so still down around 20% which is similar to the S&P priced in dollars.

The final line in gold is the S&P priced in gold. This is currently making a new low below that of March 2009. Another way to think about it is this is how much 1 S&P500 is worth per 1 ounce of gold. This is very telling and means that Gold has significantly outperformed the US Market since the 2007 high and that priced in gold equivalent the S&P 500 is actually lower than it was in 2009. The next chart (below) is even more telling and shows that ratio since the year 2000 top.

There are many inferences one can draw from these graphs, but the primary theme is that a major reason the stock market is even as high as it is, is because of the weakening US Dollar and as a result a significant decline in the purchasing power of the American consumer. So, the stock market is up, but the American consumer's purchasing power has fallen, thus leaving them with less money at the end of the day. Just because the S&P is at a certain level, that same level doesn't buy you near what it used to and doesn't mean things are "better".

Another way to look at this is from a constant dollar perspective. The market's are quoted at current currency rates, but an investor who invests in the year 2000 invests in year 2000 dollars and is then at the mercy of both the numerator (stock performance) and the denominator (currency) over time. Therefore performance could and should be measured on a constant dollar basis (also known as purchasing power).

On that same chart from 2000 (below) that shows the S&P500 priced in gold, I also track the USD's trade weighted performance.

In March 2000 the trade weighted dollar index was around 106. Today it is around 74. Suppose that someone bought at the top in March 2000 when the S&P was at $1500 and the dollar was at 106. Now suppose that person sold today at S&P $1200. That would be a loss of $300 or 20% on the S&P...not that horrible on the surface. So that person cashes out and now wants to buy something with his $1200 cash, but he finds that his $1200 is not near what it was in 2000. In fact, on an average basis it now buys 30% less (106-74=32/106=30%) than it did in the year 2000. So in reality that investor has likely actually lost around 50% in their purchasing power over the 11 year period. They would have been much better off buying something that held its value better, however, they lost on both fronts.

This is best shown on that same chart with the S&P priced in Gold. That ratio has fallen a staggering 87% from a ratio of 5.3 S&P's per 1 oz Gold in March 2000 to only .66 S&P's for 1 ounce of gold today. Assuming Gold is a good measurement of purchasing power (which I do not totally agree with, but I think directionally it provides a good starting point), this shows that investing in the stock market since 2000 has actually set you back SIGNIFICANTLY...a lot more than the surface 20% decline implies!