Upside Potential in Ross Stores
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Ross Stores (NASDAQ: ROST) has provided a nice ride for investors over the last years, shares of this discount retailer where trading near $11.5 at the beginning of 2008, and are now over $61.5. The company is trading near all-time highs and at a premium valuation versus competitors, but the price is justified via Ross Store´s efficiencies and growth opportunities. Growth potential is far from over for investors in this efficient retailer.
Ross Stores has produced an increase of more than 25% annually in earnings per share over the last five years, that´s way above what other companies in the industry have delivered, and a solid reason behind the extraordinary returns the stock has experienced over the last years.
The main competitive advantage behind that growth is the company´s ability to offer a comprehensive variety of merchandise at widely discounted prices. Ross Stores sells fashion items at prices which are between 20% and 70% below those charged by other retailers.
The retailer purchases later in the buying cycle than department and specialty stores, and that allows the company to take advantage of supply/demand imbalances. The vast majority of merchandise is acquired through opportunistic purchases of cancellations and overruns. Most orders have one delivery, and generally exclude promotional and markdown allowances and return privileges, enabling buyers to obtain significant discounts on in-season purchases.
One important aspect to consider when a company is basing its competitive advantages in low pricing is the sustainability of its profit margins. If low prices are hurting margins too much, the strategy can backfire and end up working against investors.
This is not the case for Ross Stores, however, the chart from YCharts shows that gross profit has been increasing faster that sales in the last years, which has produced a surge in gross margins from the 22.5% area some years ago to more than 27.5% currently. The company keeps providing discounted prices to its customers, but economies of scale and efficiency gains are translating sales into higher margins for shareholders.
In the following table we can compare Ross Stores against competitors like TJX (NYSE: TJX) J.C. Penney (NYSE: JCP) and The Gap (NYSE: GPS). The company has much higher growth rates and Return on Assets than JC Penney and The Gap. When compared with TJX the profitability figures are similar, but Ross Stores has achieved a higher growth rate in the last five years.
The most relevant competitor for comparison purposes seems to be TJX, and Ross Stores has higher profitability and growth rates, while both companies are trading at similar valuations. The numbers show that Ross Stores is trading at reasonable valuation levels, and the price is justified by its strong fundamentals.
Ross Stores has delivered extraordinary returns over the last years, and those returns are sustained by strong competitive advantages and efficient operations. Even near record highs, shares of the company are trading at reasonable valuations, and they still offer ample potential for further gains in the middle term.
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