Company of the Week – Stein Mart (SMRT)

The company of the week this week is Stein Mart (SMRT), a retailer offering fashion merchandise at a discount to larger department and specialty stores.  As we did last week, we will be looking reviewing the company using Warren Buffett’s approach for the Business & Management Review.  We will also use Benjamin Graham’s overall philosophies to guide our Financial & Value Review.

Business & Management Review

1.  Is the business simple and understandable?

     Yes.  The company’s overall operating plan is simple:  sell quality finished goods at lower prices than their competitors. 

2.  Does the business have a consistent operating history?

     The company was founded in 1908 by Sam Stein, the current chairman’s grandfather.  Since then, the company has operated under the same basic plan.  The company has had a positive net income for over 10 years, but only recently began offering a dividend.

3.  Does the business have favorable long-term prospects?

     In the latest annual report, management claimed that the year was the most profitable on record.  Though they recently reported their same-store sales had declined by 2.8% (analysts had estimated a decline of 2%), we believe this is just due to market fluctuations and the fact that the prior year had such high sales.  Long-term, we believe Stein Mart will continue to face growing sales and profits.  In the event of a recession, the target upscale customers would not be affected significantly and would still have disposable income.  In fact, with Stein Mart’s prices being lower than traditional department stores, it could be expected that in a time with lower disposable income available, customers may spend more time at Stein Mart than other stores.

4.  Is management rational?

     In 2003, the company faced a number of difficult decisions that would hurt the company in the short term but benefit the long term.  The management behaved rationally and focused on the long-term goals.  Though inventory levels were declining as planned, sales and earnings were below the management’s expectations.  However, the management did not abandon their plan and continued to make the changes that were necessary for the future of the company.  12 new stores were opened that year while 16 unprofitable stores were closed.  It is very pleasing to see management that is willing to close stores that are not profitable instead of keeping them for the sake of having a higher number of stores.

5.  Is management candid with its shareholders?

     We are not very thrilled about the management’s investor relations website, as it has limited information about management, but it does provide earnings reports, past annual reports, press releases, and other useful information. It can be found at:  http://ir.steinmart.com/index.cfm

6.  Does management resist the institutional imperative?

    The management resists the institutional imperative every time they expand without taking out long-term debt.  The company currently holds no long-term debt, and plans to continue that trend by funding all expansions with internally generated cash.  This is a strategy that goes against the grain in today’s business atmosphere.
 

Financial and Value Review

Upon our review, we find Stein Mart to be suitable for the enterprising investor following Benjamin Graham’s value investing strategy, but not suitable for the defensive investor.  The company is too small for the defensive investor, does not have a significant dividend history, and has not increased earnings per share over the last 10 years enough for the defensive investor.  However, we find the company to have a PE ratio of 16.75, and a price to book ratio of 1.95.

We believe the company has potential to reach $18/share in the next few years. 

Neither of us held a position in Stein Mart at the time of publication.  Also, please read our disclaimer and Our Methods.

Please discuss this article in our forums.  Your comments help us mold our future articles.

Using Discounted Cash Flows

One of Benjamin Graham’s greatest teachings is that when looking at the stock of a company and trying to value it, we should use the same approach as we would if we were to purchase a small business from a neighbor.  The only difference between the companies is size, so why should we as investors continually place more emphasis on the market’s speculation of stock price than the actual value?  Well, we shouldn’t.  We should only care about the intrinsic value of the company, and only purchase securities that are trading below that value.  Sounds pretty simple, doesn’t it? 

The complication comes in when we try to figure out the value of the company.  How does one go about doing that with accuracy?  Well, there are many approaches – one of which is the Discounted Cash Flow Analysis.  The idea is simple:  predict the future cash flows of the company and discount them to the present using the time value of money.  But Benjamin Graham taught us never to base our investments on predictions of the future, which are habitually wrong.

I believe that the intelligent investor can get around this prediction issue by believing another of Graham’s philosophies – the margin of error.  If you put a significant margin of error into your prediction, it becomes more reliable.  If I value a company at $35/share, but refuse to buy it unless it is trading below $26.25, I have a margin of error of 25%.  At that level I can feel more certain that I am not wrong.  

David Meier from The Motley Fool has written a nice article about using DCF, and the pitfalls against it.  The article can be found here:  http://www.fool.com/news/commentary/2005/commentary05032803.htm

Quicken.com has a very helpful tool for estimating the value of a company based on DCF.  To use it, go to http://www.quicken.com/investments/seceval/ and enter a ticker symbol.  After the evaluator comes up for the stock you enter, click on 5. Intrinsic Value.  There you can select different growth and discount rates to see how they affect the value.

~Ben

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