Carnevale: Ross Stores a Buy on Bad News (Update 1)

Tickers in this article: ROST
By Chuck Carnevale

Updated from 11:04 am, to include closing prices on the last page.

NEW YORK ( F.A.S.T. Graphs ) -- The stock market can often overreact to even the slightest amount of bad news. On Thursday, Ross Stores (ROST) was down big, over 7.5%, on heavy volume. There were two pieces of news that could be attributed to this drop, although neither was of great importance to my way of thinking.

First, Piper Jaffray announced that they substantially lowered their price target from $86 a share to $71 a share. That represents a significant premium to their stock price currently at $55.23. However, I believe that this is the least likely reason for the big drop in Ross.

The most likely reason for their price drop was that Ross issued a press release announcing a modest increase in sales for the four weeks ending March 3, 2012. This seems to have greatly disappointed the myopic stock market. Although the announcement was below expectations, I for one do not believe that it justifies a 7% drop in their already reasonably-priced shares. In fact, I contend that it is completely irrational to believe that the intrinsic value of a publicly-traded company like Ross Stores could change by as much as 7% in one day.

Ross Stores The Business

I am more interested in the business behind the stock than I am the stock itself. I believe it is much easier to analyze the fundamentals behind a business in order to calculate its intrinsic value than it is to try and guess where the stock price might go next. The venerable Ben Graham taught us all that the market is bipolar with his famous Mr. Market allegory.

Ross Stores has one of the best operating histories of any company I've ever examined. It is the largest off-price apparel and home fashions chain in the United States. The company operates over 1,000 Ross Dress for Less stores in 33 states and over 100 dd's DISCOUNTS stores in eight states. The company earns high returns on capital and their stores operate with high gross and operating margins. Ross Stores is fiscally fit with only 8% debt to capital and generates consistently strong cash flows.

Perhaps most importantly, they bring these strong fundamentals to the bottom line while simultaneously offering customer savings of 20% to 60% off department and specialty store prices. Consequently, the company's business model has proven to be very recession resistance as their historical record of operating earnings clearly illustrates.

The following graph plots earnings per share (the orange line) and dividends (the blue shaded area) only on Ross since 1999. Ross has consistently grown earnings at over 17% per annum, and the dividend has grown along with profits. On this graph the slope of the orange line is 17% (Ross's growth rate) and simultaneously represents a PE ratio of 17. Based on this graph, I believe Ross Stores represents the quintessential example of what a growth stock should be. Notice how Ross Stores' earnings growth actually accelerated during and after the Great Recession of 2008.