With JBH approaching my first buy in point (around $10), i...

With JBH approaching my first buy in point (around $10), i thought i would make some additional comments.

Firstly the negatives:
(a) lots of talk about a high return on equity. Yes this is true, but what is the 'value' of that equity. The current value is around $2.10. So when people are talking about a great return on equity they are comparing it to equity per share of around $2.10. Yet what is the share price?????

If someone is happy to sell me their JBH at equity value, ie $2.10 per share, then by all means, i will be buying (and not as a trade against market price).

So when the equity per share is $2.10, and the current share price is $10.50 odd, using ROE is dangerous. Why? because the share price is much higher than the equity price.

The only thing we can really say, is that JBH has consistently achieved a high return on equity on its business model over the years. This implies that there is at least some historical feature that gives JBH a high barrier to entry (otherwise competitors would enter the market place and errode that competitive advantage, this in turn would reduce the ROE).

Return on capital deployed (or ROIC) has also been good.

(b) The real key here is whether JBH can maintain those barriers to entry that stop competitors entering their sales space.

I am arguing that due to a structural change (ie the internet and online sales), JBH will NEVER go back to where it was in the market place several years ago.

Consumers are becoming increasingly savvy about buying online. This is a strategic threat that WONT GO AWAY. Regardless of competition in physical store fronts, JBH will always be a price taker on sales price due to comparisons with online sales prices.

This second negative can't be over emphasised. Even if most of JBH physical shop front competitors exit the industry, they will still face the pressure from online distributors. These online distributors are both local and international. The online compeition is NOT GOING AWAY. In fact its going to become more aggresive as technology further enhances online buying.

The postives:
(a) The essential positive with JBH is its low cost of doing business. It has the most efficient business structure out of the major physical shop front retailers (just look at WOW light and sound, now in liquidation).
(b) its focus, unlike woolworths with Dick Smith, JBH is not a 'division', its the whole hog. JBH is a specialty retailer with just one focus: technology/entertainment sales. This is important because management has a sole focus.
(c) its balance sheet. JBH has a relatively clean balance sheet. Yes it took out more debt from the share acquisition, but look at cash flow relative to debt. Their debt is not a problem.


So the key with JBH in my opinion is the price paid for their share. JBH is both finished as a 'high growth stock' and due to increased consumer knowledge about buying online, its essentially going to be a price taker for its products sold.

So the return for individual investors will be dictated by the price they pay for the share. (with a growth stock, overpaying for a share can sometimes be covered by the growth prospects, ie over pay in year 1, but by year 5 because of growth, that overpayment wont matter anymore)

THIS WONT BE THE CASE FOR JBH.

Essentially one needs to buy it at a price that reflects its low growth, whereby one is receiving more of, in buffett terms, a bond yield.

At a price of around $10 i receive an earnings yield of approximately 12% assuming minimal growth. This provides my margin of safety. I can get a risk free return by putting the money in the bank for 6%. Investing in shares is not risk free, therefore i want adequate compensation for that risk.

My assumption of 12% has risk, because we dont yet know what the final landscape will be for margins. JBH margins could still contract further. With same store sales declining, yet cost of operating each store rising, there is a risk of further increases to the 'cost of doing business'.

My margin of safety becomes the difference between the 12% current earnings yield and the risk free rate of 6%. One would normally require a sustainable risk return of 3-4% above the risk free rate. This would equate in the current environment to around a 7-10% return.

Therefore at $10 i can 'bear' a 2% reduction in earnings yield (ie a further drop in JBH profit), yet still have my margin of long term safety.


Further more at $10, i wont be going full hog. This is the price (or near to it) that i will start to take positions. I will also be patient. There is no need to go fast and furious into the position.