The projection of Best Buy’s future financial performance can be made through ratio analysis. The ratios can showcase the company's past financial performance and allow one to predict whether the American entity will succeed in the future. The table below indicates the relevant financial metrics and ratios of Best Buy Inc. The entity's fiscal year ends on the last day of January every year.
| 01-02-2017 | 01-02-2018 | 02-02-2019 | 01-02-2020 | 30-01-2021 | |
| Sales revenues | 39,403m | 42,151m | 42,879m | 43,638m | 47,262m |
| Net profit | 1,228m | 1,000m | 1,464m | 1,541m | 1,798m |
| cash | 3,921m | 3,133m | 1,980m | 2,229m | 5,494m |
| Net profit margin | 3.12% | 2.37% | 3.41% | 3.53% | 3.80% |
| Return on assets | 8.97% | 7.43% | 11.28% | 10.82% | 10.38% |
| Return on equity | 27.03% | 24.04% | 42.32% | 45.52% | 44.58% |
| Current ratio | 1.48 | 1.26 | 1.18 | 1.10 | 1.19 |
| Debt/equity | 0.28 | 0.22 | 0.40 | 0.98 | 0.69 |
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The entity's revenues increased every year over the past five years. The upward trend in sales is a positive sign for the entity. Based on this trend, there is a strong case for Best Buy realizing an increase in the total revenues in 2021. In 2020, the entity realized a revenue growth rate of around eight percent despite the negative ramifications of the coronavirus on businesses (“Best Buy Co. Inc . ,” n.d.) . The pandemic led to travel restrictions, and consumer spending decreased due to the increase in unemployment. Given such a scenario, it was expected that Best Buy would be affected by the slowdown in spending. Before the coronavirus hit, the entity's sales growth rates in 2019 and 2018 were 1.8% and 1.7%, respectively. The huge increase in the sales growth rate to 8% means that the virus positively impacted the entity's sales. The pandemic caused an increase in demand for products that assisted people to work, cook, connect, and receive entertainment in their homes. The virus is not expected to be eradicated in 2021, and travel restrictions may be imposed based on the infection rates. For this reason, there is a significant probability that Best Buy's revenues will increase considerably in the coming years, beginning with 2021. The entity's cash flow decreased between 2016 and 2018 before increasing in 2019 and 2020. The increase in cash flow in the last two years is a positive indicator of the entity’s financial performance. The increase may be attributed to the strong growth in revenues. Given that the revenues are projected to increase beyond 2020, it is highly likely that the cash flow will also increase in 2021.
The entity’s net income increased each year from 2017 to 2020. In 2020, the net income grew by around 16 percent from 2019's value, while in 2019, the net income growth rate was 4.56% (“Best Buy Co Inc.,” n.d.) . The greater growth in net income in 2020 was an impressive feat in light of the coronavirus. The entity thrived despite the negative effects of the virus on travel and businesses. The increase in the net income between 2017 and 2020 means that Best Buy's future outlook is promising. In addition, the coronavirus has no end in sight, and, for this reason, Best Buy's profits are likely to increase in 2021.
The entity’s net margin ratio increased every year between 2016 and 2020. The increasing margin is a positive sign since it means that Best Buy’s ability to convert more sales into profits has been increasing (Tracy, 2012) . The metric's upward trend means that Best Buy is likely to realize a higher net margin in 2021. The return on assets ratio is an indicator of the entity’s efficiency with regard to managing its assets to generate net profits (Bowers, 2019) . The return on assets has been trending downwards since 2018 despite the increase in the net profits. There is a strong probability that the metric will reduce in 2021. The return on equity has been trending upwards and downwards over the past five years between 2016 and 2020. The metric reduced slightly from 45.42% in 2019 to 44.58% in 2020. The reduction can be attributed to the greater increase in equity compared to the increase in net profits. Given the projected increase in net income in 2021, there is a high likelihood that the return on equity will increase slightly.
Best Buy’s current ratio decreased between 2016 and 2019 before increasing in 2020. Over the five years, the entity has managed to meet its short-term debt responsibilities with only its current assets (Tracy, 2012) . In this sense, it is expected that its current assets will continue to exceed its current liabilities in the years to come beginning from 2021. The metric is expected to trend upwards in the coming years due to strong cash flows caused by the projected increase in revenues. The debt-to-equity increased between 2017 and 2019 before decreasing in 2020. The decrease in the metric is an indicator of a reduction of debt relative to investor financing. The decrease in debt may be attributed to the repayment in debt caused by the strong cash flows realized in 2019 and 2020. Given the projected increase in the cash flows, it is expected that the debt-to-equity will reduce in 2021 as Best Buy repays its debt obligations.
Decision to Buy, Hold or Sell Best Buy’s Stock
Best Buy Inc. has realized a stable growth in dividends over the past five years as a result of its continued growth in net profits. The retailing entity has increased the dividend paid to the shareholders for eight consecutive years. In 2016, the American entity paid dividends worth $1.43 per share in the fiscal year 2016. In 2020, the amount increased to $2 per share. When the quarterly dividend in the first quarter of the fiscal year 2021 is annualized, the yearly dividends paid in 2021 will amount to $2.20 per share (Trainer, 2021). In such a case, current shareholders are expected to receive a yield of two percent. Best Buy's growth in its dividend payments is backed by its strong free cash flow. The retailing entity realized a cumulative seven billion dollars in free cash flow while paying more than two billion dollars in dividends between the fiscal year 2016 and 2020. The Dividend Discount Model can be used to value Best Buy's stock. Based on the model, Best Buy's current-day price is worth the sum of the expected dividend payments when discounted back to their current value. The four-year average dividend growth is around eleven percent, and the year-to-date growth rate is around seven percent. Based on the DDM, the stock's fair value is $199.44 (“Best Buy Co., Inc . ,” n.d.) . Its current price is 115.76 as of 5 th April 2021, and, for this reason, it is undervalued. There is an expectation that the undervalued stock will go higher and, in such a case, one should buy the stock to benefit from the expected upside.
Best Buy’s stock can also be valued through the discounted cash flow method. In this technique, the stock’s intrinsic value is computed by discounted the retailer’s free cash flows to their current value. Between 2021 and 2030, it is estimated that Best Buy’s levered cash flows in the ten-year period will be $2.55 billion, $1.12 billion, $2.07 billion, $2.13 billion, $2.18 billion, $2.23 billion, $2.28 billion, $2.33 billion, $2.38 billion, and $2.43 billion (“Estimating the Fair Value,” 2021) . The present value of the cash flows discounted at a rate of 8.7% will total $14 billion. The terminal value is $37 billion based on a cost of equity of 8.7% and a growth rate of 2% that is based on the 10-year government bond yield. The present terminal value of $37 billion is $16 billion when it is discounted at the rate of 8.7%. The fair value of Best Buy's stock is $115.52. Based on the comparison with the current market price of $115.76, it is evident that the entity's stock is slightly overvalued. In this case, based on the model, one should sell the stock since it is overvalued.
The DCF is the most reliable and accurate valuation technique based on theory. For this reason, the results from the DCF valuation should take precedence over those of the DDM. Based on this assessment, one should sell Best Buy’s stock.
Important Accounting Issues
A key accounting issue affecting retailers, including Best Buy, is the change in the method of accounting for leases. The Accounting Standards Update related to leases requires companies, including Best Buy, to recognize leases in the balance sheet and to provide information regarding lease arrangements in the notes section (“Accounting for leases,” n.d.) . The adoption of the new accounting guideline related to leases prompted Best Buy to combine its lease and non-lease elements for all categories of assets in the fiscal year 2020. The retailing entity does not record leases with an original term of less than one year in its consolidated balance sheet. In addition to the ASU standard related to leases, Best Buy adopted other new ASUs in the first quarter of the financial year 2021. The ASUs relate to the credit loss measurement on financial instruments, intangibles, fair value measurement, and client’s accounting for implementation expenses realized in a cloud computing arrangement that is a service contract. According to the retailer, these ASUs had an immaterial effect on the entity’s financial results, cash flows, and financial position.
Another important accounting issue that affects the retailing industry and Best Buy is inventory markdowns. The markdowns are essential for retailing companies, including Best Buy Inc., to ensure current inventory is sold before the next season's inventory is purchased. A high inventory turnover is required for retailers to ensure companies have sufficient cash reserves. In addition, high inventory turnover is beneficial to Best Buy since it allows it to reduce blockage in finances and take complete advantage of bulk purchases. Best Buy values its goods at the lower of cost or net value realized from sale through the creation of inventory markdown adjustments. Such adjustments point to the excess of cost over the net recovery the entity expects to obtain from the eventual sale of inventory. Best Buy does not record any adjustments for the inventory that it is able to return to its suppliers for full credit (“Best Buy Co. Inc . ,” n.d.) . The markdown adjustments entail uncertainty since the computations require Best Buy's management to formulate assumptions and to utilize judgment regarding expected revenues and incremental expenses the firm will realize for its current inventory. The estimates incorporate the assessment of historical recovery rates in addition to various factors, including product type, predicted consumer demand, product lifecycles, and vendor return rights. Evidently, there are uncertainties involved in the estimation of inventory markdowns. Over the last three years, the entity’s markdown adjustments have remained stable. However, if there was a ten-percent change in Best Buy’s markdown adjustment as of the end of January 2021, its net earnings would have been impacted by nearly thirteen million dollars in fiscal 2021 (“Best Buy Co. Inc . ,” n.d.) . Such a change would have negatively impacted the entity’s financial results and position.
References
Accounting for leases . (n.d.). AICPA. https://www.aicpa.org/interestareas/frc/accountingfinancialreporting/leases.html .
Best Buy Co., Inc. (n.d.). Finbox. https://finbox.com/NYSE:BBY/models/ddm-sg .
Best Buy Co Inc . (n.d.). MORNINGSTAR. http://financials.morningstar.com/ratios/r.html?t=BBY®ion=usa&culture=en-US .
Best Buy Co. Inc . (n.d.). Form 10-K 2020. https://d18rn0p25nwr6d.cloudfront.net/CIK-0000764478/7f2f273e-9cff-4b97-9f91-0150210498d9.pdf
Bowers, S. L. (2019). Accounting and corporate finance for lawyers . New York: Wolters Kluwer.
Estimating the fair value of Best Buy Co., Inc. (NYSE:BBY) . (2021). SIMPLYWALL.ST. https://simplywall.st/stocks/us/retail/nyse-bby/best-buy/news/estimating-the-fair-value-of-best-buy-co-inc-nysebby .
Trainer, D. (2021). Analyzing Best Buy’s dividend growth potential . Forbes. https://www.forbes.com/sites/greatspeculations/2021/02/05/analyzing-best-buys-dividend-growth-potential/?sh=44dd7a606403 .
Tracy, A. (2012). Ratio analysis fundamentals: how 17 financial ratios can allow you to analyse any business on the planet . RatioAnalysis. net.
