After getting hammered in the second half of 2015, Macy’s Inc. (M) stock is off to a hot start this year, but the rally in Macy’s stock may be getting ahead of itself.
As the nation’s largest department store operator, Macy’s is struggling as much as anyone with declining consumer spending in its industry. The strong dollar also crimps results, although that excuse is overblown.
These kind of macroeconomic headwinds limit what Macy’s can do about weak results. In the case of Macy’s stock, shares are up because of cost cuts and giving more cash back to shareholders.
It’s financial engineering 101. With little to no hope for organic growth, Macy’s needs to pare expenses, buy back shares and hike the dividend in order make earnings per share and total returns go up.
The market always loves this type of strategy at first. Anyone holding M stock gets more cash and can count on EPS growth.
The problem is that this ardor can’t last forever.
A company only has so many employees to lay off and so much cash to play with. At some point, revenue growth needs to take over to drive profit expansion. One day, the M stock price will fully reflect the benefits of these moves — and then the market will turn on it again.
Macy’s Stock Is Ready to Repeat History
Just look at what happened a year ago when Macy’s first unveiled its restructuring plans. Shares tumbled initially, but then gained its footing as the plans took root. Halfway through the year, Macy’s stock was up 11%. Pretty great for the stock market at the time.
But the reality of revenue weakness caught up to shares. Second-quarter results were a disaster. The holiday selling season was even worse. Macy’s can’t get people to spend more in its stores, and that always gets to a stock eventually.
Value investors see the beaten-down price-to-earnings ratio on Macy’s stock and can’t help but believe it’s a bargain. Throw some cash in there to sweeten returns, and shares rise for a time. And then poor sales ruin everyone’s good mood.
Even after the run, the valuation remains attractive. Macy’s stock still trades well below the S&P 500 and its own five-year average on a forward earnings basis.
It won’t last. Sales are in decline.
Value investors overlap with long-term investors, and long-term investors don’t bet on shrinking businesses that have lost their way. Why stick around to watch results deteriorate further?
Go ahead. Take a closer look at Macy’s stock. This is what a value trap looks like.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
