2023-04-19 10:49:31 ET
Summary
- Best Buy has a solid underlying business and the time has come once again to stand ready to purchase shares.
- Selling puts to earn an attractive return while committing to buying shares lower seems like the most optimal strategy.
- Operating results and share prices exhibit relatively low volatility, which presents a unique opportunity to earn yield.
Best Buy ( BBY ), a leader in the retail consumer electronics market, has consistently demonstrated robust results over the years in a highly competitive industry. Their well-established market position, in addition to management's competent execution, has proven to be a winning formula in terms of consistent cash flow and capital return to shareholders. While Best Buy's end market is saturated and the potential for robust growth is diminished, right now the shares lie in an attractive spot, and we think it's a good time to get involved in the story.
Thus, investors looking for a low-risk opportunity to generate income and capitalize on Best Buy's underlying strengths should consider selling put options. This strategy would allow option sellers to potentially buy shares of the company at an even more attractive price, or simply pocket the 12% annualized premium.
Financial Results
In short, if you look at the company from a bird's eye view, Best Buy's financial performance is strong, and proves the company's ability to deliver consistent and stable results while over-earning in opportunistic markets.
Over the last year, the company took in ~$46 Billion in revenue, while keeping $894 Million in Free Cash Flow.
In fact, if you remove the pandemic windfalls, you'll see very low volatility when it comes to operating results. Between FY 2016 and FY 2019, Best Buy saw Revenues of $39.4 Billion, $42.1 Billion, $42.8 Billion, and $43.6 Billion consecutively. Free Cash Flow stayed within an even tighter range, with results of $1.96 Billion, $1.45 Billion, $1.58 Billion, and $1.82 Billion consecutively.
These results show that management has historically done a good job of capitalizing on their market opportunity.
Add back in the results from the pandemic, and the picture becomes even more impressive. During the chaos of 2020 and 2021, when supply chains were snarled and rolling lockdowns were ever present, the company was able to leverage digital channels and their huge store footprint to capitalize further on the surge in demand for entertainment and work from home electronics. In these periods, Revenue jumped to $47 Billion and $51 Billion, and Free Cash Flow leapt to $4.1 Billion and $2.5 Billion.
Taken together, Best Buy has the profile of a mature retail market leader, combined with the upside of a company ready to pounce on opportunities that present themselves. An attractive combo.
One final question; What is management doing with all of these retained earnings?
As it happens, thankfully, they're returning capital to shareholders.
The company pays a 5% dividend and is buying back shares hand over fist. In the last 5 years alone, outstanding share count has dropped 23%. This is unlikely to continue apace as it's not likely that Best Buy will see another massive business driver (like the pandemic) crop up again soon. However, it's clear management has prioritized returning capital to shareholders.
Volatility
While Best Buy's financial results are impressive, the company's stock also exhibits an unusually low level of volatility, making it a great candidate for income-generating strategies such as selling put options.
Between the start of 2015 and the end of 2019, Best Buy's stock only saw an average trading range of 2.48% on a daily basis.
Currently, the stock has an ATR of 2.53%, a stat that mirrors this pre-pandemic reality. As Best Buy continues to return to operating in a "normal" market, underlying volatility going forward should continue to decrease.
A key reason for this low volatility is the company's size and resilient business model which allows it to effectively weather market challenges and sustain steady cash flow.
Additionally, analysts covering Best Buy demonstrate relatively low variance in their EPS expectations. This indicates a high level of confidence in the company's ability to deliver consistent results - which drives down daily trading ranges.
The Trade
Now that we've covered the what and the why , let's take a look at the how .
Sure, interested traders could purchase the stock as an investment and go on with their day. The financial results, capital return, and volatility profile all support this.
However, we think there is an even more attractive way to approach this setup: selling put options on Best Buy stock. For those unfamiliar with this type of transaction, here are some basics to know.
Selling put options involves offering the right for someone to sell you stock at a predetermined price before a specific date. In return, you receive a premium for taking on this obligation. With Best Buy's relatively low volatility and stable performance, this strategy is particularly appealing.
For this trade, we like the June 2nd, $67 strike puts:
By selling these, you'll receive a premium of $0.98 per share, or $98 per option contract (as of writing). In the event that Best Buy's stock remains above the strike price at expiration, you'll simply pocket the premium as income. If the stock price falls below $67, you may be obligated to purchase shares, effectively acquiring them at a discount vs. where they are currently trading.
Here's a chart of the potential P/L profile, which shows the profit and loss on the y axis, and the current price on the x axis. The stock is trading near $74, and it shows this trade's breakeven at $66.02:
Finally - looking historically, it's been a good time to buy the stock anytime it's dipped into the $60-$70 range.
Risks
While the trade idea presents clear rewards, there are some risks to consider as well:
Competitors : The industry landscape could change, with new competitors entering the market or existing competitors gaining market share, potentially impacting Best Buy's financial performance. Walmart ( WMT ) and Amazon ( AMZN ) both sell electronics and are 10x-100x more well capitalized.
Macro Risks : If the Fed doesn't get inflation under control, consumer sentiment might continue to worsen and negatively impact customer purchasing decisions. This would hurt financial performance and profitability.
Increased Perceived Outcome Variance : If analysts begin to widen their perceived range of outcomes, then that may impact implied volatility in the shares which could lead to Vega losses in the trade.
Technical : While $60-$70 per share has been a good area to buy stock in the past, it may not continue to do so and the stock may break down beneath this zone, causing losses.
Summary
In conclusion, Best Buy offers a unique low-volatility profile and stable operating results, which make it an ideal candidate for selling put options as an income-generating strategy. While the risks shouldn't be dismissed outright, the overall profile of the trade seems skewed towards positive expected value.
For further details see:
Best Buy: Earn 12% While Waiting To Buy It Lower