FTSE 250 household appliance and electricals retailer AO World (LSE: AO) has soared since 15 September. I am not surprised at all, as this saw the release of its eye-catching H1 fiscal year 2025/26 trading update.
Two elements were particularly noteworthy in my view, and evidently that of other investors. First it raised the lower end of its adjusted pre-tax profit range for the full year to £45m-£50m from £40m-£50m.
This reflects strong projected growth in its business-to-consumer retail revenues. These are expected to rise by 11% year on year for fiscal year 2025/26. Total revenue is expected to be up 13%.
And second, the firm announced its first-ever share buyback – of £10m — which tends to support price gains.
How was it doing before this?
I think any surge in the cost of living is a risk to its profits. It is these that ultimately power any firm’s share price over time.
However, so far AO World’s discounted pricing through its ‘Five Star’ membership programme is succeeding in retaining customers and attracting new ones.
Its fiscal year 2024/25 results released on 18 June saw a record like-for-like (LFL) annual profit before tax of £45m. LFL sales measure a retail business’s growth from its existing stores and space, excluding new store openings or closures.
This was up 32% year on year, which the company attributed to the expansion of its Five Star programme. More broadly, the year saw over 650,000 new customers buying from the firm for the first time.
AO World’s 12 December acquisition of musicMagpie is also yielding results – contributing £30m in revenue since then. The firm sees the buy as enabling it to further enhance its customer offer in the electricals market.
Analysts forecast AO World’s profits will grow by an annual average of 36% to end-fiscal year 2027/28.
So where does this leave the valuation?
A share’s price and its value are not the same thing. The latter reflects underlying business fundamentals, while the former is whatever the market will pay at any given time.
I believe the best way to quantify the price/valuation gap is through discounted cash flow analysis.
This clearly identifies where any stock price should trade, based on cash flow forecasts for the underlying business.
In AO World’s case, it shows the shares are 60% undervalued at their current 98p price. Therefore, their fair value is £2.45.
Will I buy the stock?
I am seriously tempted to buy the shares, given how packed with value they look. And I have found over the years that an asset’s price tends to converge to its fair value over time. In this case, given its very strong earnings growth forecasts, I think it may be sooner rather than later.
That said, I am always wary of buying stocks priced under £1 as this increases the price volatility risk of the stock. At my late point in the investment cycle (aged over 50), I prefer to minimise my risk profile. So I think for now that I will not be buying the shares.
That said, if I were even 10 years younger, I would buy them. Consequently, I believe they are well worth other investors’ consideration.
