It’s been about two months since I made my bullish call on Big 5 Sporting Goods Corporation (NASDAQ: BGFV), and meanwhile stocks returned -4.6% versus a loss of around 4.8% for the S&P 500. this piece, I want to determine whether or not it makes sense to add to the position, hold or sell. I will make this decision by looking at “fresh off the press” financial results and considering the stock as something separate from the underlying business. Finally, I will offer a brief update on my latest options trade here, and will shock some of my regular readers.

I know we’re all busy solving the world’s problems and watching cute baby elephant videos, so we don’t have time to waste on superfluous verbiage. I will add to my Big 5 position today. I think the last quarter is actually impressive if you compare it to the first 13 weeks of 2019. I think that’s the most reasonable period to compare the latest results. I consider the dividend to be very well covered, and therefore Mr. Market‘s 6.3% yield is a wonderful gift in my opinion. I would not want to insult Mr. Market by refusing him his gift, so I will accept. We are often told that we should be greedy when others are afraid. It’s a simple concept to grasp, but difficult to put into practice in the heat of the moment. I’ve had many conversations with people who lament that they didn’t buy the market in March 2009, but these people are missing the point. They forget that buying while others are running away from the scene is actually very difficult mentally, and that’s why most people don’t. I think many investors will look at this company’s price chart five years from now and think “if only”. I don’t want to be one of those people, so I’m buying aggressively again. Finally, I am no longer selling puts here today. Please contain your shock. In my opinion, stocks are so cheap that if you have the capital to cover a short sale, you might as well use it in the stock.

Financial Performance of the Big 5 Sporting Goods

The company has just released its financials, and before I get into my analysis of those, I thought it would be helpful to offer what I consider to be the highlights of the call:

1. Strong earnings that are at the upper end of the company’s forecast. Well ahead of any pre-pandemic first quarter in the company’s history.
2. Healthy cash position and no outstanding debt.
3. Difficult comparisons with last year’s results which were skewed by the effects of the pandemic.

The CEO made a statement that I think is entirely reasonable, so I take the liberty of sharing it with you.

Stepping back for a moment, over the past two years our business has experienced unprecedented growth in the face of unprecedented challenges. While some of these challenges are now beginning to subside, our earnings results continue to significantly exceed historical levels. We certainly set the bar high last year. But keep in mind that we don’t need to beat last year’s results to produce another very profitable and successful quarter and year. We are very optimistic about our ability to continue to capitalize on many of the recent drivers of our success, including favorable product trends, increased merchandise margins and significantly reduced print ad spend, coupled with and more flexible pricing. And perhaps most importantly, we have a very experienced team that knows how to run our model to drive results.

Ok, so getting into both the ‘nitty’ and the ‘gritty’, the bottom line here was either pretty strong or pretty weak, depending on your frame of reference. Compared to the first 13 weeks of 2021, the last quarter was rather soft. In particular, turnover and net profit fell by 11%, and a tearful eye by 57.75% respectively. Although the capital structure remains quite strong, cash has dropped dramatically compared to the same period last year, while total liabilities have increased by $5.5 million, or 1%. At first glance, this should give investors like me pause.

The thing is, 2021 may not have been a typical year, and so comparisons with it may be less insightful than others. Specifically, you may recall that there was a global pandemic at the start of this decade, and that drove Big 5 sales well above normal. For this reason, I think my readers might be interested in comparing the first 13 months of 2022 (the first “post-pandemic 1st quarter”) to the first 13 months of 2019 (the last “pre-pandemic 1st quarter”). Since I’m absolutely obsessed with making my readers’ lives more enjoyable, that’s exactly what I did.

Compared to the first 13 weeks of 2019, the first 13 weeks of 2022 have been spectacular in my opinion. In particular, while revenues were virtually flat (down 1.3% in 2022), net profit was more than 447% higher in 2022 than it was in 2019. This is due to the improvement margins. Even more impressive is the fact that the capital structure has improved significantly compared to the same period in 2019. Long-term debt has gone from $45.4 million then to $0 now. Back then, cash was about 1% of total liabilities, now it’s about 13%. It’s a much less risky business now than it was in 2019.

I wrote in my previous missive about the sustainability of the dividend, and nothing has happened in the meantime to make me change my mind on this point. If you want to understand my thinking on the dividend, I recommend you check out my Big 5 article before the end.

The stock

As my regular readers know, I consider “the stock” to be quite a separate thing from the underlying business. In effect, the company is an organization that sells sporting goods for profit and pays owners a sustainable dividend from those profits. The stock, on the other hand, is an instrument that is bought and sold several times a year and reflects the changing mood of the crowd. In particular, the stock price reflects the crowd’s opinions about the company’s distant future. The mood of the crowd seems capricious, and looks incredibly scary in my opinion. Given that they are governed by such different dynamics, I am now of the opinion that the stock is actually a poor indicator of the health of the underlying business. That’s why I treat it as a separate entity. History has also shown me that the lower your entry price, the greater your subsequent returns, which is why I’m quite obsessed with trying to buy stocks at the best possible price.

My usual victims know that I measure the cheapness of a title in several ways ranging from simple to complex. From a simple perspective, I like to look at the relationship between price and some measure of economic value, like earnings, free cash flow, book value, etc. The more an investor pays for $1 of future economic benefits, the lower their returns will be. In my previous missive on this name, I was as excited as ever because the price to pound ratio fell to 1.2x and the price on sells fell to 0.29. Things are also compelling today in my opinion, by the following:

While stocks remain as cheap as they were when I last reviewed this company, the dividend yield is near multi-year highs. Paying relatively less and getting relatively more is something I’m generally in favor of.

In addition to simple ratios, I want to try to understand what the market currently “thinks” about the future of this company. To do this, I turn to the work of Professor Stephen Penman and his book “Accounting for Value”. In this book, Penman tells investors how they can apply the magic of high school algebra to a standard financial formula to determine what the market “thinks” about a given company’s future growth. Some people I’ve recommended this book to “in real life” have complained that it’s a little too academic. You can also find this information in Mauboussin and Rappaport’s book “Expectations Investing”. Anyway, this exercise consists in isolating the variable “g” (growth) in a fairly classic financial formula. Applying this approach to the Big 5 today suggests that the market is assuming this company will be out of business in about six years, which I consider pleasantly pessimistic. Given all of the above, I am very comfortable buying stocks at current prices.

BGFV Stock Options Update

In my previous missive on this name, I announced that I had sold 10 January 2023 puts with a strike price of $8 for $0.90 each. These are currently offered at $0.60, so I’m comfortable with the trade at this time. While I normally like to try to repeat success by selling out the money put on a business I like, I think there is no reason to do so in this case. With a dividend yield north of 6%, the shares themselves are priced so attractively, I’m just going to buy more. It’s rare for me. Although I really like selling put options, I can’t recommend doing it in this case. If you have the risk capital to write put options, you might as well use it to collect the 6% dividend here.

Conclusion

I’m a fan of the “Far Side” cartoon series, written by the great Gary Larson. Years ago there was a cartoon where a cat was lured into a clothes dryer by a dog with a misspelled sign for “cat fud”, and the thought bubble above the dog’s head reads “Oh please! Oh please!” I don’t mean to trigger any copyright strikes, but if you Google “Far Side cat fud” you won’t be disappointed. Anyway, I remember this cartoon watching the Big 5 stocks trading pre-market this morning. They are down 7.5% as I type this. I feel like the dog in that cartoon, and I hope Mr. Market keeps sniffing at that dryer door and eventually jumps in because I know the lower my entry price, the higher my return important. So, Mr. Market, do us a favor and get into that dryer.

Update: Although they rallied somewhat in early trading, Mr. Market did not disappoint and now offers these stocks at a dividend yield of around 6.3%. I consider this dividend to be sustainable, and therefore I will be buying more this morning. I think recent financial results have been pretty good relative to a reasonable benchmark, and I like the market overreaction. Also, while I don’t normally watch such things, I really like the 41% short interest here, because there’s a chance a short squeeze will give stocks a nice bounce from here. .