Stock Option Investment Advice

Is Best Buy a Buy? – Argument Against

Best Buy (BBY) is a specialty retailer of consumer electronics, home office products, home appliances, and entertainment products in the United States, Canada, and China. One of their competitors, Circuit City, recently declared for bankruptcy and is currently in the process of liquidating their inventory. Most investors expected this event to be a catalyst of Best Buy’s stock; however, the current recession has had a prominent effect on the retail sector causing retail sales to steadily decline. One of the hardest hit areas of the retail sector is the consumer discretionary area. Consumer discretionary items refer to products consumers do not need, but are products they want to buy when they have extra money. During a recession people have very little money that can be spent on discretionary items which is why these companies tend to struggle during recessions.

At first glance, Best Buy may look like a cheap stock on an earnings basis, trading at 9.7 times earnings and with a share price $26.82 as of March 2, 2009, but it’s not. I expect the numbers to be revised downward as the retail sector continues to face difficult times. One of Best Buy’s competitors, Wal-Mart (WMT), which operates retails stores with several segments including consumer electronics, is able to price similar products at much lower prices than Best Buy causing consumers to shop at Wal-Mart rather than at Best Buy. Also, the fact that Circuit City is still liquidating their inventory isn’t helping Best Buy because Circuit City is selling their products at significantly reduced prices that Best Buy cannot compete with.

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Many of Best Buy’s suppliers, such as Sony (SNE), which is a leader in the development and production of consumer electronics, and Dell (DELL), which is a leader in the marketing, development, and manufacturing of computer systems, have already announced that they expect 2009 to be difficult and as a result they have decreased their earnings expectations for 2009. This in turn suggests that these suppliers also expect electronics retailers like Best Buy see reduced sales and also have a difficult year in 2009. Best Buy also mentioned in a recent earnings report that the music retail business has seen significant declines as consumers are purchasing fewer CD’s and instead are opting to purchases their music through products such as iTunes. In addition, sales of DVD’s are also on the decline as consumers are opting for online movie rental subscriptions through companies like Netflix (NFLX), who provides users with the ability to choose from over 100,000 DVD titles for as low as $8.95 per month.

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During a recession, consumers tend to cut back on big purchases like big screen televisions, computers, and other electronic devices they don’t need. This makes it very difficult for retailers like Best Buy to make money and reach their earnings estimates. While Best Buys’ stock has performed very well as of late, bouncing off its 52-week low of $16.42 reached in late November, I think investor’s should consider selling this stock into the recent strength as there is a lot of uncertainty in the retail sector and there does not appear to be any catalysts to stimulate this stock. Once Circuit City completes its liquidation, it will eliminate one of Best Buy’s major competitors, but more consumers will still be flocking to Wal-Mart to buy their consumer electronics products because of the cheaper prices. With that said, expect Best Buy to benefit from Circuit City’s bankruptcy, but not until after this recession is over and consumers start spending again. Until that time Best Buy looks like a “no-buy”.

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Investors considering dipping their toe into retail investing, but are concerned about the volatile market should consider using stock options to insure their positions against a loss. The purchase of a put option can be considered “stock insurance“. With stock insurance, if the price of the stock drops, the put option prevents a large loss. Investors can also use stock options to generate income. A covered call investing position is similar to leasing a house with an option to buy. For a covered call investing position, and investor sells a call option against a stock which enables an investor to make monthly income.

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[tags] United States, Canada, China, Circuit City, iTunes, DVD, BBY, Best Buy Co. Inc., DELL, Dell Computer Corp., NFLX, Netflix Inc., SNE, Sony Corp. ADR, WMT, Wal-Mart Stores Inc. [/tags]

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