hi i'm jimmy in this video we're looking
at some tricks for identifying retail
stocks that could outperform the stock
market using their inventory methods
using for how they account for inventory
so in this video we're going to try to
answer a few questions first what is
lifo and fifo how do they work and how
do they move the stocks what impact do
these valuation methods have on the
stocks
plus and this was an important one so
stick around to the end because we're
going to show you a bunch of different
retail stocks which stocks use
different
inventory methods that ultimately can
have a big they can make a big
difference on how these stocks trade now
before we jump into that i just want to
introduce you real quick to a website
that we're almost done being built they
should be up and running within the next
few weeks we've consistently said this
should be done by the end of june we're
now in june and we're looking like we're
doing fairly we're pretty on schedule
with this we're doing fairly good with
it ultimately the way the website will
work is we will take analyst estimates
for free cash flow
and right up here they show how many
analysts are projecting each individual
number this is important because if you
have more analysts projecting free cash
flow in theory that's more reliable if
you just had one take that for what it's
worth
but either way we take analyst estimates
for free cash flow we discount those
back to today for me i'm using a
required rate of return of seven and a
half percent and with that we get a fair
value of 225 per share well even if we
use a more textbook number like the
company's weighted average cost of
capital which in this case is a bit over
8.5 percent well target stock still
looks like it could be undervalued right
now now you might have seen that target
stock took a pretty big hit recently
stock dropped a bunch so this could be a
good opportunity for target stock
but if you had a required rate of return
of let's say 10
well that doesn't work nearly as well
here because we'd like to see the stock
drop below 137.
so if you'd like to sign up to get
access to this website there will be a
link in the description below and one of
the advantages signing up now before the
website goes live is for anybody who
signs up before the website goes live we
are locking in the price
indefinitely forever it's going to be
locked in the price will never go up on
you so if you'd like to sign up link in
the description below that being said
let's jump over to what is fifo and lifo
and how do they work so the first one is
fifo this is short for first in first
out then we have lifo this is short for
last in first out so let me give an
example of how which types of companies
would use each valuation each inventory
method so first let's picture a timber
company that goes out and they acquire
their inventory they buy a whole bunch
of timber and then they go out and they
buy some more timber
and then they go and they buy even more
timber they're buying it from their
suppliers well when they want to sell
some they should really sell the last
ones that they bought so they would take
some off the top of the pile that is
last in first out that is a logical that
is the type of company you might expect
that would do that another example might
be a coal company they buy a whole bunch
of coal they throw in the pile they keep
throwing all the coal that they buy on a
pile when they sell it they sell it off
the top of the pile
that's last in first out
first in first out is a company a good
example of that would be a company that
sells milk so they buy milk and then
they buy some more and they buy more and
they just when they buy additional milk
they add it to the back of the line they
add it to the bag so when a customer
comes in and buys it well they jump in
they buy the one from the front that's
the one that they sell that was the
first one that they put in first in
first out now i do want to point out
that these are
hypothetical these are inventory these
are accounting methods it is not that
they are actually tracking what they
paid for each one they are grouping you
know they buy a whole bunch of milk
and then
they try to sell that stuff first but it
is a counting number the company that
sells milk could choose to use last and
first out if they want to that's why
it's important always do the research
and look that up but i just want to
point out this is an accounting method
not necessarily
a
as the reality and this is very
important because this has a big impact
on the numbers to look at that let's
imagine that we have two different
companies we have our fifo company and
our lifo company and these two companies
we're going to have them act exactly the
same they're going to buy the same
number of products they're going to sell
the same amount of products and i want
to show you the impact that
one company choosing fifo and the other
company choosing lifo what impact that
has on their numbers and then we're
going to circle back to
which companies could be most
interesting for us to research right now
okay so the first order that both
companies are going to make is going to
cost them 100 and they're both going to
buy five units each
then their second order that they're
placing from their suppliers is going to
cost them 101
inflation has gone on a little bit so
inflation has popped up the price a
little they both buy five more units and
then they place their third order where
they pay 102 bucks per unit so they buy
five units another five units at 102
bucks per unit now
both companies we're gonna have both
companies sell 13 overall units so we
got that right up here they sell 13
units at 125 bucks apiece so both
companies are showing revenue of
16.25
well
the difference between these two is
important for the fifo company the the
first out of the 13 that they sold
they sold all five of the first units
that they bought first in first out then
they sold all five of the second order
that they made all five of those units
are gone and then they sold three of the
additional units of the third order so
there's two units left but the lifo
companies on the other hand well they
sell the last ones that they bought
first so that goes down to zero then
their second order goes down to zero and
there's two left remaining of their
first order you might already know where
this is going but just to run through
the math real quick just so we can see
it well the total cost for both
companies is obviously a little
different and this is solely because of
how they chose to account for their
inventory they're fundamentally doing
business the same way they're
fundamentally the same company but they
both chose different inventory methods
well because of that the fifo company is
showing better operating margins just
slightly but better well fast forward in
time let's clean this up a bit and fast
forward now the inflation is starting to
hit and they're placing their fourth
order from their suppliers but because
inflation is coming they decided to
increase the number of units that
they're going to buy so now instead of
102 bucks per unit they're now paying
105 bucks per unit but they both part
bought 10 units each then they placed
their fifth order their fifth order
another 10 units each but now it cost
them 110 bucks per unit
now let's to keep the math simple we're
going to say that they order another 13
they sell another 13 units
now
in reality the 125 that they're selling
it for probably would have gone up with
inflation as well but just keep the math
simple we're going to keep it the same
just to illustrate the impact from
company to company
or from inventory method to inventory
method so the fifo company first and
first out sells the first two units that
they had from their third order they
sell all 10 units from their fourth
order and they sell just one unit from
their fifth order so we can see their
costs on a line item basis and then
their total costs is 13.64 then we
switch over to the lipo company now
don't forget they're doing going the
other way the last ones that they bought
so all 10 of their fifth order are sold
and they sold three units in their
fourth order so their total cost coming
at 14 15 which is slight that gives them
slightly lower margins so once again
first in first out companies have
margins of a bit over 16 percent while
last in first out have margins about 13
okay now let's clean this up a bit and
let's do
now that the company has spent a little
too much time and this is the part
that's very related to today's situation
the company has spent a little extra
money ramping up inventory during these
inflationary environments inflation is
starting to slow down so let's say they
want to get rid of some of their older
inventory so their sixth order is just
four units each and once again they're
gonna sell 13 units at
total so the fifo company all 13 units
that they generate that they sold that
they generated revenue with all of those
get sold and we can see that their costs
are both 990 and 456 because they you
they sold the fifth and sixth orders
that was the inventory that was the
inventory that they accounted for well
meanwhile the lifo company they also
sold all their remaining inventory but
we can see the primary difference here
is that now they sold some of their
first orders that some of the inventory
that they had accounted for in their
first order and in their fourth order so
when we look at their total costs well
we can see that their total costs on
where they liquidated old inventory by
the way they call this a lifo
liquidation well their total costs are
now lower than the fifo company
so when we look at their margins well
for the first time the margins now flip
around the margins look much better for
the company that has been accounted
things uh under inventory under lifo
last in first out because now they're
getting rid of older inventory so fifo
companies tend to do better when they
have rising inventory levels and
somewhat steady inflation
if inventory levels begin to fall the
fifo company will begin to look much
better margins will look much better and
as we know when a company has better
margins their stock tends to perform
better than a company that doesn't have
margins that are good as good that being
said let's switch over to some examples
our first example comes from costco so
this is the chart of costco's inventory
going back about the past 20 years and
we can see that their most recent jump
they did have somewhat of a jump in
inventory again there's two primary
reasons things that are happening right
now that make inventory an important
consideration for companies
companies generally want inventory
levels to stay low right why do they
want to have all this extra stuff they
have to store it they have to take care
of it they have to move it around they
have to pay to have that inventory on
hand most companies want to be super
efficient don't want to carry excess
inventory but with supply chain issues
which has been a problem recently and
with higher inflation it makes sense to
buy more inventory now so when we switch
over a company like lowe's well we can
see that they actually started
increasing inventory back in 2021 and
one of the reasons again for this need
to increase inventory is because they've
been having supply chain issues and if
inflation is ramping up it makes more
sense to buy inventory today now these
are two modest examples let's look at an
example like amazon they on the other
hand have really ramped up inventory
these numbers by the way these are in
billions of dollars these are not units
these are not the number of units that
they have this is the amount of money
that they spent
on that inventory now there's two things
that will be increasing that one they
buy more but also the cost so as
inflation goes up that's going to be
baked into it but we can see here they
had a huge jump in inventory that is not
because of inflation they have added
excess inventory when we look at a
company like walmart well walmart also
has had a huge jump in inventory when we
look at a company like target again a
huge jump in inventory now i've gone and
looked at some of the statements uh
target walmart amazon
and i wanted to see what what the
companies what the management teams were
saying about the inventory levels and
most of them were saying exactly what we
might think inflation is rising and
their supply chain issues they don't
want to get caught without inventory
so what is going to have to happen is
these companies with this excess
inventory which in a normal environment
they don't want to keep they're going to
have to sell that off at some point
they're going to have to
if they're a lifo company perform what
they call a lifo liquidation they're
going to have to dwindle down their
their inventory levels and we've already
seen how that math works so now the
question might be which companies
are most
best positioned to take advantage of
this so we put together this table here
which breaks out some of the top
retailers
by
how they account for their inventories
so last in first out we've already seen
that when they companies have already
ramped up their inventory levels they're
going to have to decrease those numbers
when they do the companies in last in
first out are likely to be best
positioned to put up better than average
margin numbers so you've got companies
like walgreens rite aid target macy's
academy sports and then we look at first
in first out well we got companies like
amazon lowe's haynes crocs and under
armour these are all companies that in a
normal environment would show
better than average margins compared to
a company that reports on lifo
but
when things reverse when they have to
lower inventory which we've seen a lot
of them have increased their inventory
when they try to lower that inventory
they're not going to perform quite as
well so that is something for us to keep
in the back of our mind but the point is
look at a company like target versus
walmart which tend to be competitors
target has historically better profit
margins than walmart and walmart is at
least partially using
first and first out or other valuation
methods
compared to in a typical environment
targets last in first out which we know
will give them lower margins in a normal
environment but their margins are better
than walmart so when we look at the fair
value of a company like target well we
can see that
now we're getting a different idea
target looks undervalued right now at
the current price but what if we knew
that because their inventory method
is last in first out and let's pretend
in a year or two the inventory they're
going to try to
sell off some of their inventory they're
going to try to reduce their inventory
levels well we know that that inventory
that reduction of inventory is going to
at least temporarily improve their
margins
that temporary improvement of margins
could really help their business and the
market as the market does might
overreact to that and drive this stock
price much higher so
if we're going to do a deep dive on
target and targets a company we're
interested in owning
the question is do we want to buy it
before they perform their life for
liquidation or after
my answer the begin with no other
information is i want to do my research
beforehand to see if this were this
stock is worth buying today now i do
plan on doing a deep dive on target in
the near future because of this
information that we've found while we're
doing the research so i'll be doing a
video on this if you'd like to get
access to this website again the website
should be up and running at least for
beta testing within the next couple
weeks so if you'd like to sign up i'll
leave a link right here link in the
description below and thank you so much
for sticking with me all the way to the
end of the video i really do appreciate
it thank you i'll see in the next video