1 top FTSE stock to buy in July

Motley Fool contributor Chris MacDonald dives into why Auto Trader is a top stock to buy amid strong momentum into the summer.

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On the FTSE 100, one top performer of late has been Auto Trader (LSE:AUTO). Indeed, over the past month, shares of AUTO have jumped more than 13% at the time of writing. This move has positioned Auto Trader as a top FTSE stock to buy among many traders.

Indeed, this is a stock with incredible near-term momentum. And for good reason. However, I’m going to dive into whether these results may be sustainable. After all, I would want to see continued performance from any long-term holding.

Strong earnings and momentum make AUTO a stock to buy

There are a number of reasons I’m considering Auto Trader right now. Among these, its business model comes to mind as a key differentiating factor.

Auto Trader’s business model as an online-focused vehicle marketplace is enticing to investors. The technological innovation it has made in an otherwise stale industry is impressive. However, given the recent supply shortages in the auto market, Auto Trader has been a direct beneficiary.

In fact, Auto Trader recently noted that used car sales were up 14% over 2019 (pre-Covid) levels. Unsurprisingly, this surge in volume flowed through into Auto Trader’s most recent earnings report.

The company reported relatively solid results. I say “relatively” because revenue was actually down by 29% year-over-year. That said, this revenue decline was more than offset by impressive gross margins of 61%.

Auto Trader booked £161 million profit on £263 million in sales. This healthy profit margin allowed for a dividend of 5p per share to be declared, which works out to a small but meaningful yield of 0.8%.

Can these tailwinds be sustained?

The short-term supply and demand dislocation we’re seeing in the used car market is likely temporary. At some point, supply will catch up with red-hot demand. And at that point, valuations of all auto retailers and resellers will likely be revisited.

How long it takes for us to get there is the key question.

Various parts of the world are reopening, while Covid-19 variants continue to hit the U.K. hard. Indeed, various statements by the company this past year led to some serious selloffs. Should the pandemic drive poor financial performance, Auto Trader shares could see some serious downside.

That said, Auto Trader is well positioned as an online marketplace with a significant global presence. This fact means that U.K. investors get access to the global pandemic reopening trade sooner than otherwise may be expected from other British companies. Accordingly, it’s feasible we could see this positive momentum persist longer than many expect.

Bottom line

On the one hand, it’s easy to see why many investors may believe this is a top stock to buy. Supply and demand in the auto market is dislocated right now. Advantage goes to retailers and marketplaces selling vehicles, presently.

On the other hand, serious risks and potential headwinds could materialise. Some investors may look at the company’s trailing price-to-earnings ratio of 48-times as high.

I’m considering this stock as an intriguing speculative pick, given Auto Trader’s impressive potential medium-term upside. That said, this is a position that will need to be monitored more closely than others, so the jury’s out on whether AUTO stock will make the cut.

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.

Chris MacDonald has no position in any shares mentioned in this article. The Motley Fool UK has recommended Auto Trader. 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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