Ocado has dropped out of the FTSE 100, but could the shares be a value opportunity?

Ocado may have fallen out of the FTSE 100, but our author likes the business. He’s keeping an eye on how it develops its profitability.

| More on:

Image source: M&S Group plc

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.

Ocado (LSE:OCDO) is about to fall out the bottom of the FTSE 100 due to its declining share price. However, could investors’ lack of confidence in the company mean that the shares are undervalued? While it’s not yet reliably profitable, the business model is strong, in my opinion.

The best for less

The company has an “Ocado Price Promise”, which matches over 10,000 products to Tesco’s prices. They claim customer’s get “Ocado quality at Tesco Prices”.

I can attest to the standard myself, as I’ve used Ocado delivery for a few months now. Having personally used Waitrose and Ocado for internet shopping, I’d say the service at Ocado is better. Additionally, the range of options is arguably larger, including a selection of Marks & Spencer food, with which Ocado operates a joint venture.

The financials tell a different story

In a nutshell, Ocado’s revenue has been growing steadily and with a lot of strength, but its earnings have yet to bear fruit reliably.

Over the past 10 years, it has delivered 10.8% revenue growth annually. On the other hand, its earnings per share have decreased from £0.02 at the end of 2015 to -£0.59 at the end of 2022.

Part of the reason the earnings are in decline is that the company has to invest continuously in its technology and infrastructure. This includes automated warehouses and expansion costs related to operating internationally.

In some respects, the losses at the moment could translate to long-term gains. However, Ocado needs to be careful it doesn’t get caught in a cycle of spending to stay relevant and never translate this into proper profits. It needs competitive efficiency, not just to keep up with trends, which is very hard to cultivate.

Is this a long-term opportunity?

One of the elements of investing that Warren Buffett taught me is to be greedy when others are fearful. Sometimes, buying a company when investors have lost faith can lead to big long-term returns.

In the case of Ocado, if it manages to translate its growing revenues effectively into good earnings over the long term, I think I could be in for a big win if I buy in at this time.

However, I have to caveat this by saying it’s high-risk. While the share price may be down nearly 90% from its all-time high, some companies never make a profit sustainably. If Ocado fails to do this over the long term, eventually, it will go bust. Nonetheless, its current price-to-sales ratio of roughly 1.1 is appealing to me.

Smaller is sometimes better

When I believe I’m on to a good thing, I go all in. However, sometimes it’s not clear whether a company is going to be sustainably great. I believe I can tell early on with some companies and people, but in the case of Ocado, I’d want more evidence first.

Therefore, if I do invest, it will be part of a diversified strategy. I might start with a small allocation of roughly 2% of my total portfolio and build up over time if it starts to look like it will become profitable.

Right now, I’m on the sidelines on this one. However, it’s going on my watchlist for sure.

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.

Oliver Rodzianko has no position in any of the shares mentioned. The Motley Fool UK has recommended Tesco 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.

More on Investing Articles

Investing Articles

1 penny stock I’d buy today while it’s 63p

This penny stock's down 70% since last March, yet could be set for a big comeback as the firm rebuilds…

Read more »

Businessman use electronic pen writing rising colorful graph from 2023 to 2024 year of business planning and stock investment growth concept.
Investing Articles

Buying 8,617 Legal & General shares would give me a stunning income of £1,840 a year

Legal & General shares offer one of the highest dividend yields on the entire FTSE 100. Harvey Jones wants to…

Read more »

Man writing 'now' having crossed out 'later', 'tomorrow' and 'next week'
Investing Articles

£25k to invest? Here’s how I’d try to turn that into a second income of £12,578 a year!

If Harvey Jones had a lump sum to invest today he'd go flat out buying top FTSE 100 second income…

Read more »

Union Jack flag in a castle shaped sandcastle on a beautiful beach in brilliant sunshine
Investing Articles

2 lesser-known dividend stocks to consider this summer

Summer is here and global markets could be heading for a period of subdued trading. But our writer thinks there…

Read more »

pensive bearded business man sitting on chair looking out of the window
Investing Articles

Here’s how I’d aim to build a £50K SIPP into a £250K retirement fund

Our writer outlines the approach he would take to try and increase the value of his SIPP multiple times in…

Read more »

Investing Articles

9.4%+ yields! 3 proven FTSE 100 dividend payers I’d buy for my Stocks and Shares ISA

Our writer highlights a trio of FTSE 100 shares with yields close to 10%. He'd happily pop them into his…

Read more »

Mixed-race female couple enjoying themselves on a walk
Investing Articles

Are Raspberry Pi shares a once-in-a-lifetime chance to get rich?

With Raspberry Pi shares surging after a successful IPO, could this UK tech startup offer a long-term wealth creation opportunity…

Read more »

Newspaper and direction sign with investment options
Investing Articles

Huge gains and 9% yields: why now’s an amazing time to be a stock market investor

The stock market’s generating fantastic returns in 2024. Whether you're looking for gains or income, it’s a great time to…

Read more »