Harvey Norman (ASX: HVN) continues to struggle, yet the shares are up 7% in the last few weeks. A value trap or compelling investment opportunity?

It’s no secret we Motley Fools are fans of the sharemarket.

As well as being fun, exciting, nerve-wracking and sometimes even a little scary, we think shares offer you the best opportunity to generate significant wealth, over the long-term.

Warren Buffett is one of the world’s greatest investors, having accumulated a wealth of around $US44 billion, give or take a few million.

He hasn’t accumulated that wealth overnight. It’s taken him decades. Buffett is the very embodiment of a long-term investor.

A man on a mission

We’ve packed our own Scott Phillips off to Ohama this weekend for the annual ‘Woodstock for Capitalists’ shindig.

We’re talking about the annual general meeting of Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B), held in early May every year in Omaha, Nebraska.

Stay tuned for some of Scott’s dispatches from Omaha.

As a Berkshire shareholder, Scott will happily admit that his fellow shareholders can be a little fanatical. They probably have a right to be, though — especially as many of them have become millionaires just from their Berkshire shareholdings alone.

The opportunity to spend 6+ hours listening to one of the greatest investors speak was too much for Scott to pass up.

So much of our investing lives are spent trying to decide how to react to a constant stream of business and economic news.

It seems not a day goes by when there’s not an official or unofficial release of inflation, growth, unemployment or job ad figures.

The basics of investing never change

The lesson from Buffett?

Despite the increase in the amount of information and the regularity with which that information is being made available, the underlying basics of business and investment haven’t changed since the industrial revolution.

If we spent even a small portion of that time thinking and reflecting on the things that really matter, we’d do a much better job of investing.

That’s precisely what we do here at The Motley Fool.

Australia. Stuck in the slow lane

What matters today?

Good question.

From a big picture perspective, the Australian economy is in the slow lane.

Growth, the ultimate driver of share prices, is as rare as a straight-talking politician.

Structural changes abound — the death of manufacturing, the death of traditional retail, the mining boom and the changing media landscape, to name but a few.

Speaking of structural changes, a few weeks ago Scott Phillips went out on a limb, suggesting Harvey Norman was a buy.

Off our rockers

It was a controversial call. Feedback at the time was almost all universally negative…

“Thanks. Is this a short sell tip?”

“GET STUFFED”

“What would appear to be a declining trend in a business faced with constant deflationary price pressure, even in their best years, becomes a cascade of operating de-leverage on ALL FRONTS with no respite. And 5.5% as a yield is just not enough safety margin to provide buffering in event of further material declines.”

This week, Harvey Norman announced 3rd quarter 2012 sales fell 8.1%.

Australian sales were the major drag, dropping a rip-snorting 9.2%. Third quarter profit before tax fell even harder, down 44% to $42 million.

That brings profit before tax to $205 million in the last nine months.

Scott is currently on an aeroplane somewhere between Dallas and Omaha.

Not holding back

So we pulled in Motley Fool Share Advisor Investment Analyst Dean Morel to give his views on Harvey Norman.

Dean doesn’t pull his punches.

His first article for The Motley Fool was titled “Your retail stocks are dying”, with Dean saying a profit warning from David Jones (ASX: DJS) was “just the start of the retail sector’s death spiral.”

Here’s a summary of the share price performance of the four ASX retailers mentioned in that July 2011 article…

Company Share Price

July 21 2011

Share Price

May 4 2012

Change
David Jones 3.12 2.53 (18.9%)
Myer (ASX: MYR) 2.40 2.43 1.01%
JB Hi-Fi (ASX: JBH) 15.84 9.47 (40.2%)
Harvey Norman 2.35 2.01 (14.5%)

Over the same time period, the S&P/ASX 200 is down just 3.4%.

It’s ugly.

And based on Dean’s comments below, he’s happy to keep avoiding Harvey Norman.

Over to Dean…

“Harvey Norman is in a difficult market and management remain in denial.

 

They attribute lower average selling prices to cyclical issues such as the high Australian dollar, deflationary pressure, and intense competition.

 

The first step to a recovery is to admit you’ve got a problem. All I hear coming out of Harvey Norman is blame and denial.

 

But the greater danger for shareholders is Harvey Norman being on the wrong side of a structural change.

 

Priced around net tangible assets Harvey Norman is a cigar butt that could have a puff or two left in it, but long-term it looks like a value trap.”

 

A defenceless analyst

Scott’s not here to defend himself, so we don’t know his thoughts. We’ll check in with him next week.

But in Scott’s defence, since his buy call on Harvey Norman, the shares are up 7% versus a 3% gain for the wider market.

Margin of safety are the 3 most important words in investing.

Scott concluded his article by saying most of the downside risk has been baked into the Harvey Norman share price.

Without that margin of safety, Harvey Norman’s would have fallen faster than the price of a Sony flat panel TV.

A fight to the death

Ultimately, who’s right on Harvey Norman?

Stay tuned for Scott’s updated view in this classic bull versus bear showdown.

Who’ll be the first to blink? Scott? Dean?

Or will billionaire Gerry Harvey finally admit it’s not the GST that’s killing his business, but his company’s cheesy advertising campaigns?

Watch this space, fellow Fools.

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The Motley Fool‘s purpose is to help the world invest, better.  Take Stock is The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it’s still available. Bruce Jackson has an interest in Berkshire Hathaway. This article contains general investment advice only (under AFSL 400691).

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