Here's What Best Buy Investors Are Worried About

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Best Buy (NYSE: BBY) reported its fiscal first-quarter results Thursday before the open, and while profits were good, management's guidance for the full year was cautious, and investors whacked it with a near-5% share price cut.

In this segment from MarketFoolery, host Chris Hill and senior analyst Ron Gross consider both sides of the story for the electronics seller. On the positive side, there's its long -- and surprisingly successful -- transition into a service-centric business, its expanding gross margin, and its new CEO's plan for the future. On the negative side, if the White House keeps pressing its trade war with China, Best Buy's liable to take a hit.

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This video was recorded on May 23, 2019.

Chris Hill: Let's start with Best Buy. Second-quarter profits for Best Buy looked good. Shares down around 5%. I'm assuming that's because of their guidance.

Ron Gross: Yeah, it's all tariffs nowadays. You know, Chris, when you look into the future sometimes, and you just don't see it right? This is one of those things, with me and Best Buy. I didn't get it. I didn't think the company was going to succeed. But you know what, they've done a nice job. They've really turned the business into one of tech support, help, to a certain extent subscription services, and online sales. And I saw none of it. I just didn't see it. You can't see them all.

Hill: You've got plenty of company in that regard.

Gross: Yeah, for sure. I mean, even with the stock weakness today, Best Buy's up 25% year to date. And that's because of Hubert Joly doing a nice job turning the business. We actually now have a new CEO coming on board. She'll be the fifth CEO in company's 53 year history, Corie Barry will come on. All indications that she will continue to focus on these higher-margin subscription-based services, things like Geek Squad, things like tech support, and the company perhaps may be able to continue with this momentum.

Hill: I'm not just saying that to make you feel better. There were a lot of people who looked at Best Buy five, six years ago, before Joly came in as the CEO, and thought, "Gosh, this is a big box retailer that is Amazon's showroom." Joly made investments in the stores, made investments in the Geek Squad, and it shows up. You look at the gross margins in the second quarter, they're expanding. That is directly the result of, as you said, the high-margin business of the Geek Squad.

Gross: For sure. Also they identified things that were not going well. They made tough decisions. They got rid of the 105 Best Buy mobile stores, they get rid of 12 of the large format stores, and they doubled down on what they thought they could do to improve margins. And so far, it has worked.

I think that one of the things us investors sometimes fall prey to is, we jump on the bandwagon if something's not going well, and we project that it will continue to not go well into the future. It's human nature. I think we often do it. The great investors out there can look a little further into the future and perhaps see a turn. You can make a lot of money if you're able to identify those opportunities.

Hill: Now, let's go to what's not happening right for this company at the moment. You mentioned the tariffs. That is part of what we're seeing with Best Buy today, because they slightly raised their guidance for Q2, but they kept their guidance for the entire fiscal year flat, which is one of those things that always makes me scratch my head. Inherent in a move like that, isn't that the company saying -- look, if you're going to raise your guidance for the second quarter, it stands to reason that you would raise it for the full fiscal year. If you're keeping it flat for the full fiscal year, doesn't it stand to reason that they're like, "We're holding open the very real possibility that in the second half of our fiscal year, we're going to have to lower guidance"?

Gross: For sure, you nailed it. It's all about the math, right? If second quarter goes up, if the math just carries forward, the full year should go up, too. But, I think they're doing the right thing here. If these trade wars don't get cleared up quickly, there will certainly be an impact. They're being conservative, which I think is the appropriate thing to do. Now, they're not lowering guidance. They're not seeing things getting crushed in the second half. But they're being a little tepid in what they think the second half holds in store for us.

Hill: And as you said, in 2019, this is a stock that's been on a really nice run. Today, it's at a 52-week low, and it's dropping another 5%.

Gross: And it's only 12 times earnings. They're a profitable company, and only 12 times, which is theoretically cheap. Similar companies, peers, trade at a median of around 13 times. Twelve and 13 are similar, let's not split hairs. But neither of those two are expensive, and that's because these businesses are tough, and they ebb and flow. They have good years and good decades and bad years and bad decades. You're not going to ever see them trade for a premium to the market. But 12X, might be still a good entry point here.

Hill: Good luck to the next CEO! Tough act to follow.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Chris Hill owns shares of AMZN. Ron Gross owns shares of AMZN. The Motley Fool owns shares of and recommends AMZN. The Motley Fool has a disclosure policy.