John P. Reese, Validea 09.30.06, 12:00 PM ET
A couple of months back, I wrote in this column about Warren Buffett and Peter Lynch and their investment strategies, which I use to choose stocks. Williams-Sonoma is a company that attracts high fives from both of these strategies.
Generate excess returns with this niche financial services company that appeals strongly to the investing style of Peter Lynch.
You may not be a kitchen or interior decorating maven, but you have to like a company that has performed as well as Williams-Sonoma (nyse: WSM - news - people ) has over the long term. It is a retailer par excellence. Its chain of eponymous stores caters to the kitchen crowd, while its Pottery Barn is a mainstay for those in need of chotchkes and other nonessentials for their homes. Pottery Barn has been struggling a bit as of late, but that is probably temporary.
Both brands have been around for years, so the company is developing other concepts as a way to drive sales. These include: West Elm, which sells furniture and accessories; Williams-Sonoma Home, which sells home furnishings; and PBteen, which sells furnishings aimed at teens. In addition, thereÃƒÂ¯Ã‚Â¿Ã‚Â½s the seven-year-old Pottery Barn Kids, a retailer of home furnishings for children.
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LetÃƒÂ¯Ã‚Â¿Ã‚Â½s look at why both of these esteemed guru strategies favor Williams-Sonoma. This certainly is a ÃƒÂ¯Ã‚Â¿Ã‚Â½Buffett-typeÃƒÂ¯Ã‚Â¿Ã‚Â½ company in that it has very strong brand names and strong market presence. These are big pluses.
Financially, the company is performing well. Out of the last ten years, earnings per share have increased every year but one (they dipped six years ago). Debt is practically nonexistent (debt of $14 million and earnings of $216 million, which means that management can pay off debt using about three weeks worth of earnings).
Further, the company has earned a return on equity (ROE) over the past ten years of 17.2%, which is very good, and its ROE rate has been consistently high each year for the last decade, which is another big plus.
A test of management is its use of retained earnings for the benefit of shareholders. The strategy takes the total amount of retained earnings over the previous ten years ($8.57) and compares it to the gain in earnings per share over the same period ($1.59). Management has earned shareholders an 18.6% return on the earnings kept, which is a very strong track record.
OK, the company is performing well, but is its stock at a price worth buying? The Buffett strategy uses two analyses to calculate the long-term rate of return an investor could expect from the stock and then averages them. This needs to be about 15% or more to be acceptable. Based on the two different methods, investors can expect an annual compounding rate of return between 16.4% and 16.6% from Williams-Sonoma, for an average of 16.5%. This is a great return and helps explain why the Buffett strategy is so positive on Williams-Sonoma.
The strategy I base on Peter LynchÃƒÂ¯Ã‚Â¿Ã‚Â½s writings is also high on this stock. The P/E ratio is a reasonable 17.94 (40 is the maximum allowed), and EPS growth is a very strong 26.37%. LynchÃƒÂ¯Ã‚Â¿Ã‚Â½s famed P/E/G ratio (P/E relative to growth) is a very desirable 0.68 (this canÃƒÂ¯Ã‚Â¿Ã‚Â½t go higher than 1.0).
EPS growth between 20% and 50% is the strategyÃƒÂ¯Ã‚Â¿Ã‚Â½s target range. As noted, Williams-SonomaÃƒÂ¯Ã‚Â¿Ã‚Â½s growth fits nicely into this range at 26.37%. The final variable used by this strategy is the percentage of debt to equity, which the strategy likes to see low. Debt is only 2.68% of equity, which is exceptionally low.
I think both Buffett and Lynch would like the investment thesis here--solid fundamentals, consistent profitability, a reasonable valuation and the upcoming holiday sales season. ItÃƒÂ¯Ã‚Â¿Ã‚Â½s a real plus that both strategies like Williams-Sonoma. If you donÃƒÂ¯Ã‚Â¿Ã‚Â½t have a retailer in your investment portfolio, you may want to consider adding a little WSM.