Is Sotheby's Overvalued?

By Bobby Fisher - March 14, 2012 | Tickers: COH, JWN, BID, TIF | 0 Comments

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Sotheby’s (NYSE: BID) shares fell nine percent based on quarterly results as net income came in 21 cents below target ($1.04 actual per share versus $1.25 estimated) and auction and related revenue fell 11 percent. Even since Sotheby’s price has recovered to $37, this stock is still trading well below its prior trading range. Is Sotheby’s on sale or is it a value trap that will suffer from a decline of art and collectables?

As an auctioneer and dealer, Sotheby’s is a play on the recovery of high-end consumers and other key macroeconomic forces.  Sotheby’s investors must believe in these macroeconomic tailwinds if they purchase its shares.

Moreover, investors must ask if it is prudent to jump into luxury businesses after the recent, powerful rally in the stock market. Though it might seem hypocritical, valuation is a key issue for all firms, even those which sell goods at high price points. To address these issues, we must investigate whether Sotheby's or other companies which share customer demographics are attractively priced.

Macroeconomic Factors

Sotheby’s benefits if the rich get richer. Investors who contemplate buying Sotheby’s shares have to ask the following question: “Do I believe in the 1%?” These are the consumers of Sotheby’s high-end art. Will today’s extreme income gap between high earners and low earners persist? Or instead, will the income gap revert to historical norms through any mechanism including low-end wage inflation or progressive tax increases? An investment in Sotheby’s is a vote of confidence in the affluence of the wealthy across the globe.

Sotheby’s benefits from macroeconomic stability. Auction participants anticipate that war and international financial trouble can make for fire sales in collectibles and art. They tend to wait out any turmoil, and this waiting game brought on by Eurozone instability was thought to be the cause of Sotheby’s weak revenues.

Inflation increases art prices. Collector’s pieces increase in value with inflation. Deflation lowers prices of real assets including art and collectibles. Price appreciation driven by inflation may result in second-order effects as more people recognize collectibles as inflation-hedged investments, and this increased attention might drive auction prices higher. Even with the same number of comparable art pieces, inflation will grow Sotheby’s auction revenues.

Shop ‘Till You Drop

Sotheby’s is only one of many ways to play demand for high-end goods. Can investors find other high-end consumer stocks with better fundamentals?  Are firms that retail high price and luxury items richly or cheaply valued in general?

There are several notable firms which sell high-end goods and can be used to benchmark Sotheby’s. Coach (NYSE: COH) designs and markets luxury accessories like purses. COH shares are making new highs despite news of counterfeit purses hitting the market. Another firm which caters to high-end clients is the retailer Nordstrom (NYSE: JWN). Nordstrom's shares are near the top of their 52 week trading range. Tiffany’s (NYSE: TIF) is anther high-end retailer that sells fine jewelry items. TIF shares are trading in the middle of their $54 to $84 52 week trading range. Many insiders took advantage of Tiffany's price run up over the past six months to sell more than half of their shares.

These firms share Sotheby’s dependence on a healthy economy and a thriving upper-class.

When compared to other luxury firms, Sotheby’s is currently trading at more attractive price-to-earnings and price-to-book ratios. Among these peers it has high earnings growth expectations, either based on extrapolation of past growth or analyst estimates.  On a relative basis, it is a great way to play high-end consumer firms. Thus, investors who are looking for pairs trading might consider Sotheby's as a long and another stock on this list as a potential hedge.

Unfortunately, as a group the valuations of these high-end consumer companies seem to ignore risk. The price multiples of Coach, Nordstrom, and Tiffany’s are clearly rich and would lead to ruin if the market for high-end goods does not continue to grow at the rapid pace expected by analysts. Shares of Sotheby's and Nordstrom trade at lower price multiples and deserve a closer look.

As a basis for comparison, consider the price multiples of an exchange-trade fund which tracks the S&P 500 like the SPDR S&P 500 (SPY) ETF. This fund currently trades at an average price-to-earnings ratio of 13.36, an average price-to-book ratio of 2.02, and a price to sales ratio of 1.22. Since this ETF has a lower beta of 0.99, it has a lower market risk than these stocks which cater to the upper class. Based on their high betas and fundamental dependence on high incomes, these stocks are likely to plunge in a downturn. For this reason, investors should require lower valuations than the broader market, not higher ones.

Unfortunately, its valuations are still unattractive when compared to the broader market. Since Sotheby’s beta is 2.37, this stock’s price is very sensitive to broader market moves. Savvy investors should watch Sotheby’s and wait for further share price drops before buying. A stock with such a high beta should reward buyers with lower price multiples than the broader market taking such a risk.

Conclusion

At present, investors should wait for lower prices before bidding on Sotheby's. It is too richly valued relative to the market, and any reversion to the mean in the wealth gap could hinder its earnings growth.

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