A Deep Look at a Deep Discounter

06/19/2012 8:15 am EST


John Reese

Founder and CEO, Validea.com And Validea Capital Management

It's always valuable to break down a company by the numbers and not rely on "the story" to sell the stock, observes John Reese of Validea Hot List.

The TJX Companies (TJX) have 2 segments in the United States, Marmaxx (T.J. Maxx and Marshalls) and HomeGoods; one in Canada, TJX Canada (Winners, Marshalls, and HomeSense) and one in Europe, TJX Europe (T.K. Maxx and HomeSense).

As a result of the consolidation of the A.J. Wright chain, all A.J. Wright stores ceased operations by the end of February 2011. It completed the consolidation of A.J. Wright, converting 90 of the A.J. Wright stores to T.J. Maxx, Marshalls, or HomeGoods banners and closing the remaining 72 stores, two distribution centers, and the home office.

P/E Ratio: Pass
The P/E of a company must be greater than five to eliminate weak companies, but not more than three times the current market P/E (because the situation is much too risky), and never greater than 43. TJX's P/E is 19.26, based on trailing 12-month earnings, while the current market P/E is 16. Therefore, it passes the first test.

Revenue Growth vs. EPS Growth: Fail
Revenue Growth must not be substantially less than earnings growth. For earnings to continue to grow over time, they must be supported by a comparable or better sales growth rate, and not just by cost cutting or other non-sales measures.

TJX's revenue growth is 6.38%, while its earnings growth rate is 21.47%, based on the average of the three-, four-, and five-year historical EPS growth rates. Therefore, TJX fails this criterion.

Sales Growth Rate: Pass
Another important issue regarding sales growth is that the rate of quarterly sales growth is rising. To evaluate this, the change from this quarter last year to the present quarter (11.1%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (6%) of the current year. Sales growth for the prior must be greater than the latter. For TJX, this criterion has been met.

The earnings numbers of a company should also be examined from various different angles. Three of these angles are stability in the trend of earnings, earnings persistence, and earnings acceleration. To evaluate stability, the stock has to pass the following four criteria:

  • The first of these criteria is that the current EPS be positive. TJX's EPS (55 cents) meets this test. Pass
  • The EPS for the quarter one year ago must be positive. TJX's EPS for this quarter last year (34 cents) fits this criteria as well. Pass
  • The growth rate of the current quarter's earnings compared to the same quarter a year ago must also be positive. TJX's growth rate of 61.76% does. Pass
  • Compare the earnings growth rate of the previous three quarters with long-term EPS growth rate. Earnings growth in the previous three quarters should be at least half of the long-term EPS growth rate. Half of the long-term EPS growth rate for TJX is 10.74%. This should be less than the growth rates for the three previous quarters, which are 21.62%, 15.22%, and 47.62%. TJX passes this test, which means that it has good, reasonably steady earnings. Pass

Another strategy looks at the rate which earnings grow and evaluates this rate of growth from different angles. The four tests immediately following are detailed below.

  • If the growth rate of the prior three quarters' earnings (versus the same three quarters a year earlier), 28%, is less than the growth rate of the current quarter earnings (versus the same quarter one year ago), 61.76%, then the stock passes.
  • The EPS growth rate for the current quarter, 61.76%, must be greater than or equal to the historical growth which is 21.47%. TJX would therefore pass this test.
  • Companies must show persistent yearly earnings growth. To fulfill this requirement, a company's earnings must increase each year for a five-year period. TJX, whose annual EPS growth before extraordinary items for the previous five years (from the earliest to the most recent fiscal year) were 0.84, 1.04, 1.42, 1.65 and 1.93, passes this test.
  • One final earnings test required is that the long-term earnings growth rate must be at least 15% per year. TJX's long-term growth rate of 21.47%, based on the average of the three-, four-, and five-year historical EPS growth rates, passes this test.

Total Debt-to-Equity Ratio
A final criterion is that a company must not have a high level of debt. A high level of total debt, due to high interest expenses, can have a very negative effect on earnings if business moderately turns down. If a company does have a high level, an investor may want to avoid this stock altogether.

TJX's debt-to-equity (23.62%) is not considered high relative to its industry (355.67%), so it passes this test.

Insider Transactions
A factor that adds to a stock's attractiveness is if insider buy transactions number three or more, while insider sell transactions are zero. Zweig calls this an insider buy signal.

For TJX, this criterion has not been met (insider sell transactions are 119, while insiders buying number 59). Despite the fact that insider sells out number insider buys for this company, Zweig considers even one insider buy transaction enough to prevent an insider sell signal, therefore there is not an insider sell signal and the stock passes this criterion.

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