One of my favourite types of trade is to buy out-of-favour big-cap stocks at bargain prices. Staying true to this policy, I bought a decent chunk of shares in Next (LSE: NXT) in 2017, when the stock was trading at five-year lows.
My big mistake came at the start of this year, when I got cold feet and decided to sell. I made a fair profit, but the company’s financial performance since then has convinced me that I sold too soon.
Today’s second-quarter sales figures are a case in point. Next’s online sales rose by 12.5% during the 12 weeks to 28 July. This was enough to offset a 5.9% fall in store sales, and boost total brand sales by 2.8%.
The company said that the long spell of hot weather meant that it’s “almost certain” that some summer sales were pulled forward from August. So there’s a risk that second-half sales will suffer as a result.
This cautious assessment is probably why the Next share price is down by 7% at the time of writing. But management has a tendency to take a conservative view in sales forecasts. I think there’s a good chance that second-half sales will be better than today’s gloomy sell-off suggests.
It’s not too late to buy
Next shares have risen by 38% over the last year. But I don’t think it’s too late to buy.
The firm has a clear plan to manage the shift from store sales to online. And last year’s operating margin of 18.7% shows that this remains a very profitable business.
Free cash flow remains strong and the company has already spent £300m on share buybacks in 2018. Management said that this should increase 2018/19 earnings per share by 4.7%.
After today’s fall, the shares trade on 12.8 times forecast earnings with a 2.9% dividend yield. That looks decent value to me.
What about this 5.9% yielder?
Next’s dividend yield has fallen over the last year as the share price has risen and the board has used surplus cash for share buybacks instead of special dividends.
If you’re looking for a retailer with a higher dividend yield, one stock I’d consider is budget footwear chain Shoe Zone (LSE: SHOE).
This business has a significant element of owner management with brothers Anthony and Charles Smith occupying two key board roles and owning 50.01% of the firm’s shares.
Although the Smiths’ majority stake means that minority shareholders have little control over the business, both men have worked for the company for at least 20 years. In my view, their management so far suggests that they have worked hard to create value for all shareholders.
Why I’d buy
Two things particularly attract me to this stock. The group’s sector expertise and niche focus allows them to buy stock directly from manufacturers overseas. This results in an unusually high gross margin of 60% and a very respectable operating margin of 6.6%.
The company also benefits from a fairly low-cost and flexible store estate. This means that it’s not stuck with lossmaking stores on long leases, unlike some larger retailers.
Although profits are expected to be broadly flat this year, my view is that the stock’s forecast P/E of 11 and dividend yield of 5.8% are cheap enough to reflect this low growth. I rate this as a small-cap dividend buy.
