Why I’d buy this ‘secret’ turnaround stock over Boohoo.Com plc

Roland Head explains why he’d shift Boohoo.Com plc (LON:BOO) cash into this overlooked turnaround stock.

| 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.

A profit ratio that’s often overlooked by investors is return on capital employed. Put simply, this measures how much profit is made, relative to the money that’s tied up in the business.

History suggests that investing in companies with a high return on capital employed (ROCE) can be a profitable strategy. These firms can usually fund their own growth and often provide attractive dividends. For this reason, I’ve been looking at two high ROCE stocks in the consumer sector.

High enough for now?

Online fashion retailer Boohoo.Com (LSE: BOO) needs little introduction. The Manchester-based group’s meteoric growth has caused the shares to triple over the last three years.

But while sales and profits are still rising fast, the group’s share price has been falling. Boohoo stock has now fallen by 42% from its 52-week high of 329p.

This decline isn’t due to poor financial performance. ROCE rose from 20% to 26% last year, as profits doubled following investment in new facilities. That’s well above my rule-of-thumb minimum ROCE of 15% for high quality businesses.

This could be the problem

I see this as a great business. But with a market cap of £2.1bn, it’s now quite large. Earnings per share are only expected to rise by about 30% this year, compared to a five-year average rate of well over 100% per year.

This has left the stock looking quite pricey. Based on analysts’ consensus forecasts for earnings of 2.8p per share this year, the stock has a forecast P/E of 65 for 2017/18, with a PEG ratio of 2.3 — a long way from value territory.

I suspect these shares may have further to fall before resuming their growth trajectory. If I owned this stock, I’d consider shifting some cash into one with stronger value credentials.

An overlooked gem?

One company I may add to my portfolio is toy maker Character Group (LSE: CCT). This £90m firm has been hit by the fallout from the collapse of Toys-R-Us, but today’s full-year results suggest to me that the damage will be limited.

Full-year revenue fell by 4.7% to £115.3m, but pre-tax profit excluding currency effects rose by 6.9% to £13.4m. Underlying earnings were up 12% to 50.5p per share, while the group’s net cash balance climbed 67% to £11.5m.

Management admits that weaker-than-expected orders from international customers will hit sales over Christmas. In order to limit the damage, inventories have been kept at a lower level than usual. The business is expected to return to growth during the second half of next year.

Despite these efforts, Character’s profitability has suffered. My calculations indicate that ROCE has fallen from 57.7% in 2016 to 46.2% in 2017. That’s disappointing, but I think it needs to be kept in context — 46% is still very high.

Why I might buy

To reward loyal shareholders, the full-year dividend for 2016/17 has been increased by 26.7% to 19p. At the current share price of around 420p, this gives a dividend yield of 4.5%. With the shares currently trading on a forecast P/E of 10 for 2017/18, I think this business could be too cheap to ignore.

I’ve added Character Group to my watch list for further research. Although 2018 could be a difficult year, I believe this remains an attractive business.

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.

Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended boohoo.com. 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

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 »

Investing Articles

1 of the best UK shares to consider buying in April

Higher gold prices and a falling share price have put this FTSE 250 stock on Stephen Wright's list of UK…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

The market is wrong about this FTSE 250 stock. I’m buying it in April

Stephen Wright thinks investors should look past a 49% decline in earnings per share and consider investing in a FTSE…

Read more »

Black father and two young daughters dancing at home
Investing Articles

1 FTSE 250 stock I own, and 1 I’d love to buy

Our writer explains why she’s eyeing up this FTSE 250 growth phenomenon, and may buy more shares in this property…

Read more »

View of Tower Bridge in Autumn
Investing Articles

The FTSE 100 is closing in on 8,000 points! Here’s what I’m buying before it’s too late!

As the FTSE 100 keeps gaining momentum, this Fool is on the lookout for bargains. Here's one stock he'd willingly…

Read more »