In the search for capital growth — a rising share price — we investors can’t resist a falling or fallen share price it seems.
What’s that all about! Any non-investing layman would probably look on in disbelief as we all scrum around the latest company that has demonstrated the failure of its business model by posting collapsing profits.
Surely, might go the cry, capital growth is best delivered by robust businesses, trading well with perky growth in their chosen market niches.
It’s about turnaround potential
When a share price falls by around 45%, as Wm Morrison Supermarkets’ (LSE: MRW) has since early 2012, it’s natural to wonder whether the shares offer better value than they did before the decline.
Let’s think of better value as getting the same thing cheaper. In the case of Morrisons, that’s not the case. Instead of getting the same business as before, buying Morrisons shares now gets us a supermarket business earning around half the annual profits that it did before. So, in terms of earnings, the value seems about the same despite Morrisons’ share-price plunge.
The next question is whether Morrison has potential to earn, once again, what it did before — an earnings’ recovery. If that happened, Morrisons’ share price would surely rocket delivering the capital growth after which we all hanker. A tempting thought, but an investing proposition that’s much more difficult to achieve — sorting out a promising turnaround candidate from a no-hoper can boil down to nothing more insightful than guesswork.
Fire fighting might halt the decline
City analysts following Morrisons reckon profits will stage a modest bounce-back during year to January 2016 — up about 9%. That’s just the firm fire fighting though; it’s not some magical restoration of previous profitability on existing operations as the business returns to its purple patch.
The trading landscape has changed. Morrisons’ chairman thinks the customer shift to value-seeking is structural this time rather than cyclical, and that means an on-going fight with discounting competition, such as Lidl, Aldi and others, and permanently squeezed prices on Morrisons’ own shelves — the message is that previous profitability from the old way of doing business is not coming back.
Morrisons’ fire fighting includes slashing the prices of 1,200 of its products; finding £1 billion in cost savings over three years; improving the layout of big stores, and investing in the opening of 200 convenience stores. However, such measures won’t restore the old business at all. What they will do is create a new business.
Shifting to convenience stores, for example, is a new way of trading for Morrisons, so the firm will be looking for new growth rather than relying on a reversal of fortunes in its existing business. Perhaps that’s just as well as I think it was legendary investor Warren Buffett who once uttered that, “turnarounds seldom turn.”
What now?
Morrisons isn’t a value proposition or a turnaround candidate, I reckon. Some forward progress will probably occur from this new lower level, but a low-margin retailing operation isn’t my first choice for a decent capital-growth investment, especially one that has recently been unable to trade flat, let alone to grow.
