During the past 12 months, Marks and Spencer’s (LSE: MKS) shares have outperformed the wider FTSE 100 by around 28% as the company’s turnaround starts to take shape.
However, it’s unlikely that this rally will last, and investors could use this chance to sell up and buy Next (LSE: NXT), which has a more impressive record of creating value for shareholders.
Marks and Spencer’s gains are a direct result of the company’s upbeat trading figures. Indeed, the company beat expectations for the first quarter by reporting that clothing sales and homeware sales at established stores rose by 0.7% in the 13 weeks to 28 March, bringing a halt to four years of declines.
This impressive performance didn’t last for long. During the 13 weeks to 27 June, general merchandise sales declined 0.4% on a like-for-like basis. Food sales expanded 0.3% on a like-for-like basis.
Marks and Spencer has been trying, and failing, to re-ignite sales growth of clothing and homeware items for several years to no avail, while smaller, more nimble peers (like Next) have eaten away at the group’s market share.
And Marks and Spencer’s position in the market, as an old-fashioned, bricks-and-mortar retailer with a high-cost base, puts it at a disadvantage when trying to compete with experienced multi-channel retailers like Next.
The difference in return on capital employed between the two companies really illustrates this point. Simply put, ROCE is a telling and straightforward gauge for comparing the relative profitability of similar businesses and is an excellent way to measure a company’s success.
According to my figures, Marks and Spencer’s five-year average ROCE is a respectable 13.9%, but it’s been falling steadily. Next’s five-year average ROCE is a staggering 58.2%.
These returns mean that Next stands out from its peer group. Additionally, the company is devoted to returning excess cash to investors.
Last year, Next paid out £223m in special dividends to shareholders on top of the regular payout giving a total dividend yield of 4.6%. Figures suggest that the company’s total dividend issuance this year will give investors a yield of around 5%. City figures suggest that Marks and Spencer’ shares will only yield around 3% this year. Next intends to pay a special dividend of 60 pence per share on 2 November 2015.
Furthermore, Next is one of the few companies that has a disciplined stock repurchase programme in place. Specifically, the company will only buy back shares if it can earn an 8% return on the repurchase, for this to happen, the company’s share price has to drop below 6,827p.
This disciplined strategy has helped the company increase earnings per share by 1000% over the past 15 years. Operating profits have only expanded 350% over the same period. Earnings per share have doubled since 2011.
Still, this kind of growth comes at a cost and Next’s shares aren’t cheap. The company is currently trading at a forward P/E of 19.3, but Marks and Spencer’ shares look slightly cheaper on the face of it, as the company is trading at a forward P/E of 15.5. However, the difference in performance of the two companies over the past few years easily explains the valuation gap.
So overall, when Marks and Spencer and Next are placed side by side, Next comes out on top. That’s why I would sell Marks and Spencer and use the cash to buy Next.
Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.