There are a number of reasons why I put a stock on my ‘sell’ list. Sometimes the decision is straightforward. If I see signs of fraud or aggressive accounting, the stock is a sell. The same goes for a company that is so overburdened with debt that the equity value is worthless or near worthless. In other cases though, the decision may be less straightforward.
A positive view
Little more than a year ago, WPP’s shares were making an all-time high of over 1,900p. They’d fallen to 1,325p by the end of October last year when I wrote positively on the stock. At that time, the 12-month forward price-to-earnings (P/E) ratio was 10.4, the prospective dividend yield was 4.8% and the company had reiterated its target of long-term earnings per share (EPS) growth of 10% to 15% per annum.
The shares are now trading lower still — at around 1,250p, as I’m writing — so isn’t the stock an even better buy today? A number of things have changed since October and it’s these changes that lead me to now rate the stock a sell.
3 negative developments
Despite the lower share price, earnings and dividend downgrades mean the near-term valuation and outlook have actually deteriorated. The 12-month forward P/E is now a tad higher at 10.5 and the yield still at 4.8%.
Furthermore — and more importantly — the company has reduced its target of long-term EPS growth to between 5% and 10% per annum. The lower compounding effect of this on long-term shareholder returns is significant and makes WPP are far less valuable company than at its previous target growth rate.
Finally, Sir Martin Sorrell, the driving force behind WPP for 33 years, resigned in April. He left with no non-compete clause in his contract and armed with a contact list of clients and talent second to none. It was announced this week that he’s launching a next-generation advertising group backed by a heavyweight roster of institutional investors.
Not on my shopping list
In contrast to WPP, the Sainsbury’s share price has been on the rise. It jumped 15% on 30 April, with the announcement of a proposed merger with Asda alongside full-year results. It’s made further gains since and at near to 320p is at a level not seen since the summer of 2014.
It’s possible that the merger will be blocked by the Competition and Markets Authority (CMA), so let me deal with that eventuality first. I remain unconvinced by Sainsbury’s previous acquisition of Argos. But even on City consensus forecasts of modest EPS growth, I view a 12-month forward P/E of 15.1 and prospective dividend yield of 3.4% as unattractive. A FTSE 100 tracker fund would have more appeal to me.
If the merger with Asda does get CMA approval, I would view it as fraught with execution risk. For one thing, I see the group having to dispose of a large number of stores into a market with few buyers (the stores likely being too large for the sector’s only aggressive expanders Aldi and Lidl). And, for another thing, past major mergers in the sector — e.g. Morrisons/Safeway and Carrefour/Promodes — don’t exactly inspire confidence in smooth execution. In short, Sainsbury’s is currently off my shopping list.
G A Chester has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.