Editor's Note: Arne Alsin's column runs exclusively on RealMoney.com; this is a special free look at his column. For a free trial subscription to RealMoney.com , click here. This article was published Feb. 11 on RealMoney.
When approaching the market, investors should be aware of two kinds of risk: market risk and business risk. Market risk is difficult to control without incurring significant cost (for example, hedging through options). Sometimes investors are better off ignoring market risk. If I accurately appraise a stock and the market takes that stock below my purchase price, my response is straightforward: I'll check my figures and hold fast. It's a fact of life in stock investing that you may not get a fair quote every day that the market is open. Business risk is more controllable than market risk. It's within my circle of competence, and it's what I devote most of my time to. Controlling business risk means reviewing a company from top to bottom, paying particular attention to financial data, in an effort to determine both a company's fair value and its staying power. If a stock trades at a significant discount to the underlying business value, there's a good chance that it's worth buying. However, that doesn't mean the stock value will immediately rise to meet business value. In fact, the stock may go down even further -- like some of my picks on RealMoney.com. Here are my latest notes on some picks that have gone "down even further."
I first highlighted J.C. Penney ( JCP) 13 months ago, and I still like the stock, despite recent weakness. I know that Florida officials are investigating consumer-protection practices at Eckerd, J.C. Penney's drugstore unit, but I don't think the potential liability, if any, equates with a $1.5 billion drop in market value. While traders focus on the Eckerd allegations, the long-term value of J.C. Penney's stock will be determined by the performance of the business. Penney's stores continue their steady improvement, with January same-store sales up 5.9%, following a 4% same-store-sales increase in the fourth quarter (the best quarter since the first quarter of 1997). For the year, same-store sales were up 3.3%, the highest since 1996. This company has a lot of earnings power; my calculations indicate potential earnings of $3.50 per share in a couple of years. The consensus estimate for the fiscal year ending in January 2003 lately stands at 95 cents a share. If I'm right, investors will look back at early 2002 as a terrific buying opportunity. J.C. Penney closed Friday at $21.03.
Hasbro ( HAS) doesn't play Wall Street's common games: There's no company guidance, no pro forma earnings. Investors actually have to work (a novel concept!) with the financial data provided by the company. In the latest quarter, earnings came in at 30 cents a share, missing expectations by 7 cents. That shortfall was attributable to one-time expenses: the Argentina peso devaluation and a tax rate change. Sales, down 15%, were perceived as weak in the holiday quarter, but they were actually solid --up 5%, net of Hasbro Interactive (this division was sold), Pokemon and Furby (which had near-zero sales). The balance-sheet metrics that I track, like inventory, net debt, receivables, etc., all improved dramatically in 2001, particularly in the fourth quarter. I'm looking for at least a 10% free cash flow yield in 2002 ($220 million-plus), in front of the strongest product cycle in years. Hasbro finished Friday at $13.55.
Toys R Us
Moody's review of Toys R Us ( TOY) debt has investors in a panicky mood. Expect the multidecade consecutive string of profitability at Toys R Us to continue, however. Its stock, which closed Friday at $16.53, is now selling slightly above net tangible book value of $14.30. That number substantially understates the company's financial strength because, in part, Toys R Us' significant real estate holdings (it owns 50% of its stores) are not carried at current value, but are reported at historical cost, less accumulated depreciation. Investors should note that Toys R Us continues to gain market share at the expense of smaller local and regional toy retailers and soon, potentially, from Kmart ( KM) as well. I'm expecting per-share earnings of $1.20 this year and $1.45 next, with upside to those numbers as operational improvements begin to drop to the bottom line.