Dirt cheap and offering big dividends. So why am I shunning this small-cap?

Paul Summers isn’t convinced that this market minnow is the bargain it appears to be.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

On initial inspection, footwear retailer Shoe Zone (LSE: SHOE) looks a tempting investment. Trading on just 11 times forecast earnings before today and offering a cracking 5.5% yield, it’s unsurprising if the business catches the collective eye of those searching for value (and/or income) in a market that is looking increasingly frothy. Net cash position? Check. Growing returns on capital? Another tick.

So why am I bearish on the stock? A quick scan of today’s interim results should help to explain.

Profits tumble

In the six months to 1 April, sales at the Leicester-based, £94m cap dipped from £74.6m to just under £73m. More concerningly, pre-tax profits nosedived to just £300,000 compared to £1.9m over the same period in 2016. Much of this can be attributed to the fall in sterling following last June’s shock referendum result and an overhaul of its store estate. 

Nick Davis, CEO of Shoe Zone, did his best to put a positive slant on today’s numbers, stating that the impact of sterling’s fall would be “significantly reduced” going forward and that trading since the period end had been in line with management’s expectations. He also remarked that the company’s trial of its Big Box store concept had performed well and that the rollout would be accelerated over the rest of the year. A target of 10 such stores by the end of 2017 was set. A 24% rise in sales of Shoe Zone’s non-footwear range was also encouraging.

Based on early trading, however, the market isn’t convinced. At the time of writing, shares in Shoe Zone are down just over 5% to 178p. 

Aside from today’s poor numbers, I think there are other reasons to avoid the retailer. For one, operating margins will always be stubbornly low for this kind of business. Moreover, analysts are only forecasting a 2% rise in earning per share in the next financial year, making shares in Shoe Zone look far less like the bargain they first appear to be.

A better fit for your portfolio?

Shoe Zone’s competition must also be considered. The idea that shoppers would prefer to visit its stores when other budget retailers — such as Primark — have sites in better locations and far wider product ranges is hard to fathom. Indeed, I suspect that investors wishing to profit from those offering low-cost clothing and footwear are better off looking at the latter’s owner, Associated British Foods (LSE: ABF).

In addition to its diversified portfolio (featuring businesses in segments such as sugar, agriculture, grocery and ingredients), the £24bn cap’s presence in 50 countries means it also offers the kind of international footprint that Shoe Zone lacks. The company has a 17% earnings per share rise pencilled in for the current year with a further 9% rise expected in 2017/18. Boasting excellent free cashflow and a £190m net cash position as of April, this is one retailer that should remain resilient if retail spending to continues to drop as a result of rising inflation and slowing wage growth. If anything, I think Associated British Food offers far more protection for investors than most as consumers begin to tighten their purse strings.

Sure, the dividend yield is negligible (1.4%) and a price-to-earnings (P/E) ratio of 25 for 2017 will put some investors off completely. Nevertheless, when compared to Shoe Zone, I think Associated British Foods looks a decidedly less risky pick.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Paul Summers has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Affectionate Asian senior mother and daughter using smartphone together at home, smiling joyfully
Investing Articles

How I’d invest my first £20k ISA to target £4,900 a year from dividend shares

Looking for dividend shares in a new Stocks and Shares ISA, and want diversification too? Here's how I'd go about…

Read more »

Passive income text with pin graph chart on business table
Investing Articles

Yields of up to 7%! I’d consider boosting my income with these FTSE dividend stocks

The London market has some decent-looking dividend stocks right now, and I’m tempted by these two for growing income streams.

Read more »

Young mixed-race couple sat on the beach looking out over the sea
Investing Articles

I’d put £20K in an ISA now to target a £1,900 monthly second income in future!

Christopher Ruane shares why he thinks a long-term approach to investing and careful selection of shares could help him build…

Read more »

Mature couple at the beach
Investing Articles

6 stocks that Fools have been buying!

Our Foolish freelancers are putting their money where their mouths are and buying these stocks in recent weeks.

Read more »

Black woman using loudspeaker to be heard
Investing Articles

I was right about the Barclays share price! Here’s what I think happens next

Jon Smith explains why he still feels the Barclays share price is undervalued and flags up why updates on its…

Read more »

Investing Articles

Where I’d start investing £8,000 in April 2024

Writer Ben McPoland highlights two areas of the stock market that he would target if he were to start investing…

Read more »

View of Tower Bridge in Autumn
Investing Articles

Ahead of the ISA deadline, here are 3 FTSE 100 stocks I’d consider

Jon Smith notes down some FTSE 100 stocks in sectors ranging from property to retail that he thinks could offer…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

Why I think Rolls-Royce shares will pay a dividend in 2024

Stephen Wright thinks Rolls-Royce shares are about to pay a dividend again. But he isn’t convinced this is something investors…

Read more »