Don't Write Off Best Buy Just Yet

12/17/2009 1:00 pm EST

Focus: STOCKS

Jocelynn Drake

Financial Analyst, Schaeffer's Investment Research

Jocellyn Drake of Schaeffer’s Investment Research, says the electronic retailer’s stock sold off big this week, but it’s holding technical support and there’s too much pessimism.

Despite reporting positive earnings on Monday, Best Buy (NYSE: BBY) shares dropped sharply, with traders concerned about the company's margins being pinched. (It fell 8.5% on seven times its average daily volume Tuesday—Editor.)

Best Buy said this quarter's margins would come in below expectations due to lower prices on items like net books and televisions. The company's trailing profit margin is now below 2%, and its operating margin is just above 4%.

Furthermore, the company must contend with fierce competition from lower-priced alternatives, especially rivals like Wal-Mart Stores (NYSE: WMT) and Amazon.com (Nasdaq: AMZN), which have been turning up the heat in this holiday season's price wars.

Telsey Advisory Group analyst Joseph Feldman says pricing is even more problematic than in years past, due to a lull in new product offerings and the commoditization of popular items like big-screen TVs. Without new specialty items, Best Buy loses its edge and consumers have less incentive to pay its slightly higher price points.

Meanwhile, trading around 14x next year's earnings may make the shares seem relatively inexpensive, but Wedbush Morgan analyst Michael Pachter argued that a multiple in line with the market isn't warranted, given Best Buy's growth prospects. "Notwithstanding positive indications about the start to the holiday season, we believe the consumer electronics category will remain under pressure for some time," he wrote in a research note. "[W]e think that Best Buy's core business is exposed to flat or negative growth in the coming years."

Technically speaking, the shares of BBY have gained more than 47% since the beginning of the year, outpacing the broad market. While the equity has pulled back, it is currently perched on support at its ten-week moving average with additional support in the form of its 20-week moving average residing just below [Wednesday’s closing price of around $41.50—Editor]. These trend lines have provided rough support for the equity since mid-December 2008.

Pessimism [also] is on the rise toward the shares. The Schaeffer's put/call open interest ratio comes in at 1.17, as put open interest outnumbers call open interest among options slated to expire in less than three months.

In addition, the International Securities Exchange (ISE) has reported more than two puts purchased to open for every one call purchased to open during the past two weeks. This ratio of puts to calls is higher than roughly 61% of all those taken during the past year, pointing to a growing pessimism.

Wall Street is also somewhat skeptical of the shares. The stock has earned 13 Buy ratings, but it also sports 13 Holds and one strong Sell. If it successfully bounces off technical support, Best Buy could benefit from an unwinding of this pessimism

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