Investor Essentials Daily

This market misunderstanding can be profitable

January 19, 2024

Innovation and technology can make or break a business.

Those who can adapt to dynamic market conditions continue along its mature stage. Others face financial stress and failure at the hands of the competitive landscape.

These businesses start to fade out and lose competitive advantages. Market share gets chipped away little by little.

Profitability starts to head towards the cost of capital, accompanied by negative asset growth and shrinkage.

All of these factors are what defines a business that is entering the decline stage of the business life cycle.

Today, we will carry on looking at Macy’s (M) and examine the declining period that this famous retailer has been in within the last 7 years.

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Businesses in the mature stage are marked by peak profitability, however, this principle also indirectly leads to their demise.

Companies recognize the success of others and enter the market as it appears attractive.

There will be more competition for any established business with steadily high returns and growth potential as others will want to snag a piece of the pie.

Mature company’s competitive positioning could suffer over time if they are unable to effectively combat these threats with innovation and focused investment.

This is the exact scenario Macy’s faced in 2015.

Although there is no direct evidence, Macy’s seemed to scale down as Amazon began to rise to fame as the biggest online retailer.

Similarly, companies like Nordstrom Rack (JWN) and TJX (TJX) experienced immense growth and Macy’s customers were beginning to look at these stores as alternatives.

In the many years following major mergers and acquisitions, organic growth remained still and the firm started to struggle.

Sales were falling and store closures were becoming a routine regiment,

Macy’s shed about 41 stores in 2015, followed by another 100 the next year.

During this same period, ROA levels fell from a peak of 12% in 2015 to 6.8% in 2017. Rightfully, asset growth reflected the mass store closures as it turned to record negative levels.

Take a look.

These trends continued until 2021. The company had a promising 2022 and 2023 but is expected by analysts to return to cost of capital levels moving forward. Which brings them back roughly to pre-pandemic levels.

Now, it’s time to look at how the market values these types of companies.

In a broader sense, the market seems to slightly overly discount declining business or expects the fade to be more intense.

On average, a business in the decline stage outperformed market-implied expectations by 0.8%.

While there is a difference in the market vs realized performance, it is minimal compared to mature-stage companies.

Using this information can be significant in interpreting valuations, but investors must remain cautious as the deviation isn’t large enough to present a significant upside.

There are better opportunities for growth and mature companies.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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