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Is Sothebys (BID) a Good Stock to Bid On?

Shares of Sothebys (NYSE:BID) are as of this writing going for $35.80 per share, a price that is 19% above the price from the beginning of the year. This places the stock at a slight outperformance of the market (though sharp declines toward the end of last year actually mean that the price is down compared to a year ago). The $2.4 billion market cap auctioneer is tightly tied to global growth and carries a beta of 2.8, with auction prices for art (a primary driver of business) particularly dependent on rising incomes and wealth among the global upper class.

Auction revenues at Sothebys were down in the second quarter of 2012 compared to the same period a year ago, and this helped drive overall revenue down 18%. Sothebys was able to cut costs, notably in salaries and compensation, but the fall in sales did end up bleeding down to its bottom line. Net income dropped 33% and with share count holding constant EPS for the quarter came in at $1.24 versus $1.81 a year ago. The first quarter of the year saw considerably less business, and so the numbers for the first half of the year look very similar: a 16% decline in revenue and a 42% decline in earnings.

Chuck Royce

The market appears confident that the wealthy will be on their way back to the auction house soon: Sothebys trades at 21 times trailing earnings, which seems a bit high for a company which has struggled in the current environment, has so much market exposure, and pays a modest dividend yield of about 1%. The sell-side agrees with investors that the company has strong business prospects: a recovery of the business is expected to bring 2013’s earnings per share 23% above this year’s. Given this consensus, the forward P/E is 16; looking out further, the five-year PEG ratio is 1.1.

The largest position in Sothebys out of all the hedge funds and other notable investors in our database of 13F filers belonged to Chuck Royce’s Royce & Associates. Chuck Royce and his team increased their stake in the company 28% to a total of 6.3 million shares. Royce has been consistently adding shares since the end of last year; the fund opened 2012 with 3.3 million shares in its portfolio (see more investment activity from Royce & Associates). Caxton Associates, founded by billionaire Bruce Kovner and now run by Andrew Law, owned 1.3 million shares of the stock at the end of June, making it one of the fund’s top stocks (research more top stocks from Caxton Associates). Billionaire Ken Fisher’s Fisher Asset Management increased its own position to 1.3 million shares (find more stocks Ken Fisher likes).

Fellow auction houses tend to be privately owned, so we will compare Sothebys to two upscale retailers and two jewelers, who should be helped or hurt by the same trends in income and wealth that affect the art market. Michael Kors Holdings Ltd (NYSE:KORS) is an expensive-looking stock, with trailing and forward price-to-earnings multiples of 55 and 31 respectively, while Coach, Inc. (NYSE:COH) is slightly lower priced compared to its earnings than Sothebys: it trades at 18 times trailing earnings and 14 times forward earnings estimates. Wall Street analysts expect more convergence over the next several years and these companies’ five-year PEG ratios come in just above Sothebys at 1.3 and 1.2. However, both of these businesses saw strong revenue and earnings growth last quarter compared to a year earlier. Coach in particular might be a better value with good growth prospects as well. Tiffany & Co. (NYSE:TIF) is a good peer; its business has been stagnant recently and it trades at earnings multiples just below Sothebys. Specifically, its trailing P/E is 19 with the Street’s growth expectations implying a forward P/E of 16. Signet Jewelers Ltd. (NYSE:SIG) is a bit more middle market, and its valuation is considerably cheaper as it trades at only 13 times trailing earnings. It is probably the best buy if investors are not specifically looking for an upper class-focused investment.

We are skeptical of the growth trajectory that the sell-side has laid out for Sothebys, and the market seems to be relying on the same estimates. We don’t think the company is a buy and that Coach and Tiffany might be cheaper ways to invest in better fortunes for the wealthy.

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