Okay, let’s start with a quick disclaimer: as a fund manager, I admit that I have a bent towards stocks that display a combination of value (cheap), quality (profitable) and momentum (prices moving higher) characteristics. So given Asos’ (code: ASC:L) lofty 2014 forecast P/E ratio of 77x as of yesterday, it was clearly never going to be one of my favourites.
A quick glance at Asos’ long-term weekly chart (Figure 1) tells you why this online fashion retailer has long been a favourite of retail investors, with a share price that multiplied by over 15 times from a low around 430p in early 2010 to a high of over £70 hit in March this year.
1. THE METEORIC RISE OF ASOS SINCE 2010
So what does today’s profit warning tell us?
Asos has today informed the market that sales growth is slowing and, even more importantly, that profit margins will be a lot lower than expected (4.5% rather than around 6.5%). This follows a warning in March that earnings would be impacted this year by increasing levels of investment.
Today’s warning has now taken Asos’ share price down to around £31 at time of writing (Figure 2), less than half of its March peak but still representing a 2014e P/E valuation of 52x, before the analysts even take out their red pens and cut their earnings forecasts. So in reality, Asos’ valuation will turn out to be far higher than 52x… This at a time when the overall UK stock market is rated at 14x this year’s earnings, falling to 12.8x for 2015.
2. ASOS HAS COME DOWN TO EARTH WITH A BIG BUMP SINCE MARCH…
The lesson to be learned here is that blindly following momentum is a dangerous strategy, once that momentum has turned. Remember that following the first warning from Asos in March, the share price had already fallen from over £70 to a mid-May low of £38.50. Investors had been given plenty of fair warning to sell their stocks at a level far higher than today’s £31…
To read the rest of this article, including the strategy and 4 stocks I would look at instead of Asos, please click on the web link below: