It was widely assumed that once Amazon Inc. AMZN +0.07% start selling sport apparel companies like Footlocker Inc. FL +1.33% would have to sell up or go broke trying to compete with Amazon.
But something else is happening, take a look at Footlockers past performance since 2000.
In a rare interview with Harvard Business School that was published online earlier this month, (it has since been taken down) value investor Seth Klarman spoke at length about his investment process, philosophy and the changes value investors have had to overcome during the past decade. Klarman’s hedge fund, the Boston-based Baupost has one of Read More
What Amazon effect???
As individual investors we need to challenge our own perceptions and also other people’s assumptions. We need to think like Arthur Conan Doyle fictional character Sherlock Holmes.
By applying the method of deduction.
The Amazon effect is based upon an assumption.
Footlocker is a retailer of sports apparel, and it is widely assumed that Amazon would have highly destructive effects on footlockers ability to compete on price, inferring that sales and profitability will decrease sharply in the coming years.
Applying deductive reasoning, we first look at the facts. From the tables provided above we see that footlocker has slowly been increasing its ability to produce growing free cash flows. According to the headlines this should not be happening.
And we see more evidence in the form of high returns on equity, which means that Footlocker is able to maintain high levels of profitability while maintaining a low level of debt.
From these facts we can start explore several lines of reasoning as to how this is possible that Footlocker can maintain and even grow these high levels of profitability while competing against Amazon.
What I mean by exploring several lines of reasoning is this, you start to think of all the ways that it is possible for Footlocker to achieve high levels of profitability and compete with Amazon.
For instance, one line of reasoning could be, Footlocker operates with greater economies of scale and captive customers. Then you begin to look for facts that both support or oppose our line of reasoning. You eliminate one by one your lines of reasoning until you one is left.
“Once you eliminate the impossible, whatever remains, no matter how improbable, must be the truth.”
Arthur Conan Doyle
With Footlocker trading at 8 times earnings, which indicates an earning yield of 12.5%. You’ll be hard pressed to find a better earnings rate for your money.
Adam Parris educates individual investors for an investment organisation called Searching for Value. He does not own Footlocker or Amazon shares. This post is the personal opinion of the author. As such, it should not be construed as investment advice, nor do the opinions expressed necessarily reflect those of his employer. Follow him on Twitter @adamparris