Should You Imitate This Insider Purchase?

Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

A recent filing with the SEC has disclosed that Nina Vaca, a member of the Board of Directors at Kohl’s (NYSE: KSS), purchased about 1,600 shares of the company’s stock in late June at prices ranging from about $49.50 to about $51 per share. This brought her total direct holdings of the stock to 7,400 shares (when unvested shares of restricted stock are included) and therefore represents a considerable percentage increase in her exposure to the company.

In theory, insiders should avoid such increases in their company-specific risk in favor of diversifying their wealth, unless they have a good deal of confidence in the stock. This is our explanation for why stocks bought by insiders tend to narrowly outperform the market (read our analysis of studies on insider transactions).

A closer look at Kohl’s

The department store started off the first quarter of its fiscal year (a quarter which ended in early May) on a somewhat poor note. Kohl’s experienced a 1% decrease in revenue compared to the same period in the previous fiscal year, including a decline in same-store sales. While earnings per share was up 5%, this was entirely due to a reduction in share count as net income fell from its levels a year ago. The company generated a little over $300 million in cash from operations, most of which was returned to shareholders through buybacks and dividends.

Currently, Kohl’s trades at 12 times trailing earnings. We’re not opposed to share repurchases, but would generally prefer for them to not be the sole source of EPS growth and certainly business at Kohl’s is not looking too good at this point. Still, this is a low P/E multiple and so market expectations for the company are low. With a beta of 0.6, and a good-but-not-great dividend yield of 2.8%, Kohl’s is also something of a defensive stock.

We monitor hedge fund activity and develop investing strategies by tracking quarterly 13F filings from hundreds of hedge funds (for example, we’ve found that the most popular small cap stocks among hedge funds outperform the S&P 500 by an average of 18 percentage points per year). According to our database, Ron Gutfleish’s Elm Ridge Capital initiated a position of about 490,000 shares in Kohl’s during the first quarter of 2013 (check out Elm Ridge's stock picks).

Peer retailers

The closest peers for Kohl’s are TJX (NYSE: TJX) and Target. These companies are valued at a premium to Kohl’s, with trailing earnings multiples of 19 and 16, respectively. The P/Es improve by a few points in each case when looking on a forward basis, suggesting that analysts are expecting significant earnings growth at these fellow retailers. However, while TJX has in fact been doing well -- revenue grew 7%, and earnings 8%, in its most recent quarter versus a year earlier -- Target suffered declines on both top and bottom lines over the same period. As a result we’d avoid Target, and TJX’s substantial premium relative to Kohl’s doesn’t make it too attractive either.

The company can also be compared to Wal-Mart (NYSE: WMT) and Costco (NASDAQ: COST). Wal-Mart is the cheapest of this peer group of Kohl’s that we’re looking at in earnings terms, with trailing and forward P/Es of 15 and 13, respectively. It should be noted that the retail giant is even less exposed to economic conditions than Kohl’s, with a beta of 0.4, and despite early reports that the company was off to a terrible start to the year, Wal-Mart actually managed to report growth in both revenue and earnings in its most recent report.

Costco achieved 8% revenue growth and 19% earnings growth last quarter from its levels a year ago. However, markets have already priced in a good deal of future growth with even the company’s forward earnings multiple being above 20. We are skeptical that Costco can continue to outperform these other retailers by enough to justify its current valuation.

Conclusion

We’re not fans of the recent financial performance at Kohl’s, but the stock is certainly cheap. As such, it might be worth learning more about the company and comparing it to the slightly better-off and slightly pricier Wal-Mart and potentially to TJX as well.

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This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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