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Wall Street Seeing Value in Direct Selling
December Stock Watch

Wall Street Seeing Value in Direct Selling

The history of direct selling on Wall Street has had its ups and downs over the years. Similar to direct selling's penetration in the Northeastern United States, direct selling still has plenty of room to grow on Wall Street. But the trends have certainly improved. One method for measuring Wall Street's reception to direct selling is comparing the valuation of direct selling stocks to traditional retail stocks. Valuation is often measured as the price of the stock divided by the company's earnings per share, called the price-earnings ratio (P/E). As the following charts illustrate, in many cases direct selling companies are now valued at or above the valuations of traditional retail companies.

All estimates are First Call consensus

The trend of improving valuations is a relatively new phenomenon (last five years) and has been a key driver of the outperformance of publicly traded direct selling stocks over the last five years. The outperformance of direct selling stocks relative to the broader market is illustrated in the performance of the Canaccord Adams Direct Selling Index vs. the S&P 500 and Russell 2000 indices. The Canaccord Adams Direct Selling Index has significantly outperformed the broader market indices since 2002, despite a slight decline of its own over the last two years.

Source: Canaccord Adams and Factset. The Canaccord Adams Direct Selling Index is composed of 14 companies that utilize the direct selling (typically multilevel compensation) model for distribution. Further details on the Index are available in the Canaccord Adams “Healthy Living Monthly” publication. Past performance does not predict future results.

There are several likely drivers to the improved direct selling valuations on Wall Street, including strong growth prospects across the industry (which began several years ago, and coincided with the accelerated performance of the index). Additionally, investor optimism surrounding the burgeoning China opportunity is also a likely contributor. But another driver may be Wall Street's realization of the attractiveness of the direct selling model on a financial basis. Direct selling companies benefit from a financial model that, in comparison with traditional retailers, yields higher financial returns in most respects (see graph below). Due to the fact that capital investment is generally less intensive for direct selling-since the sales function is outsourced and product fulfillment is centralized from the company's perspective-direct selling companies typically generate higher financial returns on investment. Stronger profit margins also contribute to the higher financial returns. For example, the following comparison considers several of analysts' more utilized financial performance metrics. They include return on invested capital (ROIC=operating profit divided by invested capital), return on equity (ROE=net income divided by shareholders equity) and inventory turnover (essentially, sales divided by inventory). In each case, the group of direct selling companies analyzed posted more attractive metrics than the traditional retail companies, potentially driving the current higher relative valuation of direct selling companies.

Source: Factset, Canaccord Adams

Whatever the true driver of Wall Street's improved willingness to place a higher value on direct selling-and it is likely a combination of all of the factors mentioned-direct sellers are benefiting from a more welcoming market for equity capital.

Scott Van Winkle, C.F.A., is a Managing Director of Equity Research at Canaccord Adams and has been researching the Direct Selling and Healthy Living® industries for nearly a decade. Canaccord Adams, formed through the merger of Adams Harkness and Canaccord Capital, is a leading independent financial services firm committed to fostering the entrepreneurial economy by bringing corporate and institutional clients unique perspectives on global investment opportunities. With operations in research, sales and trading, and investment banking, its 225 professionals seek out emerging opportunities in key sectors, including the Direct Selling and Healthy Living® sectors. For more information, please visit www.canaccordadams.com.

Canaccord Adams Inc., Member NASD/SIPC. Canaccord Adams has published research recommendations on Herbalife, Nu Skin Enterprise, NBTY Inc. and USANA Health Sciences; and makes a market in shares of USANA Health Sciences. Canaccord Adams co-managed a public offering and received compensation from Herbalife within the last 12 months. Canaccord Adams has received compensation in the last 12 months from NBTY Inc. for investment banking services, and from USANA Health Sciences for non-investment banking securities-related services. Past performance is not indicative of future results and these comments are not a recommendation to buy or sell the specific securities discussed.