Are Reports Of Barnes & Noble's Death Greatly Exaggerated?

The following was originally published at The Morning Monte. 

The narrative for years has been that Barnes & Noble, Inc BKS is dead. In fact, all brick-and-mortar retail is dying if not dead already. Let’s face it, if your first thought when you want to buy something is to go to a store, you may just be … old. Why bother when click, click, click, Amazon.com, Inc. AMZN is now shipping it to you. Well, according to Barron’s, the news of Barnes and Noble’s death is greatly exaggerated. In fact, after the article in Barron’s, the B&N jumped almost 10% on Tuesday. Barron’s went so far as to call B&N a bargain. Let’s see what we think.

Before we jump into the charts that are produced by our models, let’s say a few words about the inputs because it is important to understand how dependent the models are on the inputs. In our model for BKS we are inputting a required return of 8%. That means that we that the value distribution generated for the stock is what the stock is worth if we assume we get our 8%.

Below is the output of our back-of-the-envelop Monte Carlo. The interpretation of the chart below is that the fair stock price should be in the neighborhood of $11.50, but there is a decent chance that if B&N manages to grow its residual earnings, it could be worth even more than it is today.

Given this chart, one my ask why the stock jump 10% Tuesday.

It is always good to ask what others may be thinking, and the chart below suggests some answers. What if 8% is too much to ask for a required return. As an investor, we require a return to compensate us for both the use of our capital and for the risk that we may not get our capital back. Once could argue that 8% is a lot to ask for a company in today’s low interest rate world. Maybe you think that B&N is fairly stable now having fought off Amazon for so long. After all, now Amazon is trying to open stores. Running brick-and-mortal book stores is something that B&N knows quite a lot about compared to Amazon. Right now B&N operates 640 locations as compared to Amazon’s … one … single … physical … store.

I don’t pretend to have an answer to this question, but I do know that if you reduce the required return to 7% from 8% (5% of which you are getting in cash in the form of a dividend) the output of the model looks like the following chart.

Notice that this is saying that there is no chance that it is worth as little as the current share price. Again, to get this dramatic change in valuation, the only change I made in the model inputs was to change the require return from 8% to 7%. This is why I think that it is important to play with the models. If you are fine getting paid 7% to own B&N, maybe this is worth a look. If you think that B&N is so risky that you require 8.30%, then the chart is going to say stay away.

This sensitivity to the required return is unfortunately an issue in most financial models because that required return is what the models use to value future earnings forever.

This input dependency is why it is important to also look at other items. For example, the value breakdown chart shows that much of the value of the stock is explained by the book and short term earning. This suggests that the stock is less dependent on long-term speculative growth, and therefore less risky.

Personally, I am of mixed minds about Barnes and Nobel as an investment. I find it hard to be bearish about brick-and-mortar retail because you are not reading this in a book you bought… However, as a long-term hold that just throws of cash, it may be just fine.

However, as a final point, there is a Barnes and Noble about 10 blocks from where I live, and I do really like going there. I buy books there too.

The author does not hold a position in Barnes & Noble stock and has no plans to acquire one for 24 hours.

The Morning Monte is “high-level,” and any investment requires a deeper analysis than is presented here. The comments in The Morning Monte are intended to help guide your research and ground you in the fundamentals. In no way should the comments in The Morning Monte be taken as advice to buy or sell a particular equity. Some of the statements are forward looking. As such, these statements are speculation–so beware! The comments represent the views of the author and are not necessarily the views of The Morning Monte™ or PRUDENA™

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