On September 13, 2005, the shares of Best Buy Co. fell $ 5.14 to $ 45.22 on the New York Stock Exchange, a decline of 10.2%. The decline followed the release of its second quarter 2005 financial results. Best Buy is a large North American retailer of consumer electronics and appliances, with over 700 stores in the United States and Canada, including the Future Shop chain. Best Buy reported earnings of 37 cents per share, compared with 30 cents for the same quarter of 2004. However, its 2005 earnings included an expense for stock- based compensation. If the second quarter of 2004 had included this expense, earnings for that 2004 quarter would have been 26 cents per share. Sales revenue rose 10% for the quarter, including a 3.5% increase in same- store sales. (Same- store sales, which exclude the effects of new store openings, are a closely watched indicator of retail company performance.) Its gross profit rose to 25.5% of sales from 24.2% a year earlier. In its news release accompanying the financial results, management predicted earnings of 28 to 32 cents per share for its third 2005 quarter. This prediction included the effects of Hurricane Katrina, which, in late August 2005, caused widespread devastation in parts of the southern United States and led to a brief closing of 15 company stores. Management also announced plans to open 86 new stores in the United States and Canada during the fiscal year ending February 25, 2006. While management expressed concerns about the effects of high gasoline prices on consumer spending, it reiterated its guidance that future annual growth in earnings from continuing operations would be about 26%.
Analysts had estimated second quarter 2005 earnings of 38 cents per share, and third quarter earnings of 34 cents.
The New York Stock Exchange Composite Index closed at 7,578.25 on September 13, 2005, and at 7,762.60 on September 12, 2005. Best Buy’s stock beta, as per its website, is 1.84. The risk- free interest rate at this time was approximately 0.0001 per day.
a. What percentage return on Best Buy’s stock price would you expect on September 13, 2005, strictly as a result of market- wide (i. e., systematic) factors? Use the market model and show your calculations.
b. What was the abnormal return on Best Buy’s stock on September 13, 2005? Is this return consistent with securities market efficiency? Explain why or why not.
c. Evaluate ( in words only— no calculations required) the persistence of the news (i. e., the increase from 26 cents per share to 37 cents per share) in Best Buy’s second quarter 2005 earnings.