Why I’d consider buying this battered growth stock ahead of FTSE 100 high-flyer Burberry

Paul Summers explains why he’d opt for an out-of-favour growth stock over Burberry plc (LON:BRBY) at the current time.

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Shares in FTSE 100 luxury goods firm Burberry (LSE: BRBY) fell almost 5% in early trading this morning as investors digested the company’s first update on trading in its current financial year. 

Retail revenue rose 3% at constant exchange rates to £479m over the 13 weeks to the end of June — a performance described as “solid” given the changes afoot at the company. Comparable sales rose by the same percentage. 

In keeping with the trend experienced by other fashion retailers, Burberry reflected on strong growth in its digital offering with sales in the Asia Pacific region going particularly well. Decent performance here and in the Americas was offset, however, by lower demand from tourists in the UK and Continental Europe. Performance in the Middle East continued to be weak due to “macro factors“.

Despite this mixed update, Burberry made no change to its guidance for the rest of the year, adding that there was likely to be “some easing” of currency headwinds and that it was looking to achieve cost savings of £100m. Investors will now be hoping for a positive reaction to the debut collection from Chief Creative Officer Riccardo Tisci, due in September. 

Having traded at less than 1,100p just over two years ago, Burberry’s shares have been on fine form ever since. Had you invested back then, you’d have roughly doubled your money based on yesterday’s closing price (ignoring dividends). For such a market juggernaut, that’s a seriously good return.

The only problem with this is that any prospective buyer will now need to shell out 26 times earnings for the stock based on analyst expectations for the current year. That’s not completely unreasonable considering its huge net cash position and the consistently high returns on capital employed it achieves. That said, such a valuation does leave the £8.7bn cap little room for error, providing some explanation as to why today’s rather average numbers were poorly received by the market.

All told, I’d be tempted to wait for a pullback before investing. 

Speaking of which…

An alternative option for those wanting to own a slice of an upmarket brand could be Ted Baker (LSE: TED). 

Shares in the £1bn cap have dropped almost 30% since March based on what appears to be investors’ aversion to the retail sector combined with a less-than-enthusiastic reaction to its latest trading update. 

Group revenue rose 4.2% over the 19 weeks to 9 June — noticeably less than some analysts were expecting — as a result of dodgy weather in Europe and America combined with a more challenging trading environment in general.

Notwithstanding this, I think there are reasons to be positive (or, at least, less pessimistic) about the company’s outlook. Like Burberry, Ted’s online offering performed admirably over the reporting period with sales rising 33.6%. Elsewhere, wholesale climbed 18.9% in constant currency, leading the company to maintain its target of “at least high single-digit growth” for FY18. I also agree with its management’s view that the prudent approach to expanding its store estate means Ted can remain flexible and responsive to consumer demand in a way that some retailers can’t.

To cap things off, Ted Baker’s stock is also a lot cheaper than that of Burberry at 17 times forward earnings. A forecast 2.9% dividend yield isn’t huge compared to some but it’s adequate compensation while holders await a recovery. 

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 of the shares mentioned. The Motley Fool UK has recommended Burberry and Ted Baker plc. 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.

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