Intrinsic Value Assessment: Big Lots, Inc. (BIG)

It has a good management team, a strong balance sheet to weather a storm, and it has carved out a small niche that it operates well in. My best guess, and it’s just that, a guess, is that it will continue to do about $4-$5 billion in sales at a 37-40% gross margin, with about $150-$225 million in net profit, pay a $1-$1.50 dividend per share, continue to buy back stock, and produce $175-$250 million per year in free cash flow.

It has minimal debt, is profitable, and produces, relatively, a lot of cash.

As a traditional value-type company, this fits perfectly in that box.

However, that is purely quantitative and does not take into consideration the future of the business and its qualitative aspects. What I did wrong early in my investing career was exactly that — I did not look at non-financial aspects of the business, nor did I try to think logically about the future of the company and its industry.

It operates in a declining industry that is very competitive. It’s often hard to develop a sustainable competitive advantage in its industry, the business is cyclical, not recession proof, and has done well recently on the back of a temporary global pandemic. On top of all of that, the company isn’t “cheap” with a large margin of safety.

Using what I consider to be the most likely input assumptions, the DCF model produces an expected annual rate of return over the next 10 years of 7.24%.

It is not enough to simply analyze a company in a vacuum and make an investment decision. Investors must compare their expected return of one investment to that of another option available. Your dollar can only be invested in one place at a time — choosing the optimal place for that dollar to be invested is equally as important, if not more important.

The return result from the aforementioned DCF model is not a bad return necessarily, especially given risk-free rates and other similar instruments, but for me, it’s also not a “screaming buy” for a company in this industry with its future prospects.

All of this has been under the assumption of today’s price, approximately $68 per share, and using my inputs for the DCF model. Let’s take a look at what happens if we change those two variables — purchase price and model input assumptions.

Starting with the share price, let’s assume we purchased the stock at $15 instead of $68. Why $15? Because that’s the price you could’ve bought during the lows of March 2021. Had we bought at $15 instead of $68, the expected annual return jumps from 7.24% to over 40%!

You might be saying, “well, hindsight is 20-20”. If you are, you’re right in a sense, but also wrong. Sure, we can now see that Big Lots had a fantastic fiscal year in 2020 due to the pandemic, which no one could’ve predicted with certainty at the very beginning of the pandemic. However, I adjusted my model to not include 2020’s results as they were an anomaly. That means, we are analyzing this as if 2020 hadn’t happened and we had the same data we would’ve had in March 2020.

The second variable I want to look at is the model input assumptions. I just mentioned how I adjusted my DCF model to not include 2020’s results. Not doing this is all too common of a mistake for investors, specifically new investors.

When I was first starting out investing, I made this mistake all the time. Just because a company has one good break out year, that doesn’t necessarily mean that the future results will continue to grow from there. Rather, it is often more likely that the company will revert to historical norms.

Without adjusting for this anomaly and holding all other variables constant, the DCF model produces an expected annual return over the next 10 years of 32.44%, in comparison to 7.24% in my most-likely-scenario model.

If the adjustment isn’t made, investors are often mislead to believe a stock is worth significantly more than it truly is.

Nearly all companies have a price in which it is a good buying opportunity.

If the stock were to pull back again to levels that provide a similar expected rate of return to what we saw in March 2020, without any deterioration to the business, Big Lots may be worth a deeper look and consideration for investment.

You can read the full Intrinsic Value Assessment for Big Lots, Inc. (BIG) here, and use our TIP Finance tool with its Intrinsic Value Calculator to quickly and easily derive a company’s intrinsic value — I use this calculator for all of my investment analyses.