I’ve always had a big aversion to growth stocks whose share prices soar to massive P/E valuations, and I’m always expecting the first hint of less-than-perfect sales and profits to result in a big price crash.
And I’m starting to wonder if the sound of the death knell for a growth stock really might consist of me saying something like “I’m starting to see ASOS shares as possibly not overvalued,” as I had started to soften my bearish stance on the stock.
Before this week, big falls had already happened at ASOS (LSE: ASC) a couple of times, with its price having peaked twice before falling back quite hard. But that was nothing compared to the chaos that happened this week, as a profit warning led to a 40% share price crash. At today’s price, the shares are down 60% so far in 2018.
Although full-year sales growth expectations have been cut back to around 15%, from previous hopes of 20%-25% growth, the real crisis is one one of eroding margins — the company has slashed its operating margin predictions from 4% to 2%. ASOS is planning on cutting capital expenditure to save around £200m this year, but that’s really not what a highly-value growth star is supposed to need to do.
The question is, have the shares fallen far enough to be worth buying now? On previous forecasts, the new share price would suggest a forward P/E of 23, which is still some way above the FTSE 100‘s long-term average.
That might still be fine for a company with solid growth expectations, but after this week’s news I can see earnings forecasts being slashed dramatically — and I wouldn’t be surprised to see a new P/E still up in the 40s. At this stage, that’s still way too high.
Although its share price wasn’t pushed to the same extreme valuations as ASOS, I’ve always seen Superdry (LSE: SDRY) as being somewhat precarious. Fashion is risky at the best of times (the clue is in the word itself), but companies relying on the fickle popularity of one specific brand strike me as among the riskiest.
After a warning about poor sales in November and December, the shares plunged, and they’re now down almost 80% so far in 2018. Underlying pre-tax profit is now expected to come in between £55m and £70m, compared to £97m a year ago, so that’s a big drop.
If the shortfall from earlier expectations (analysts were predicting pre-tax profit of £71m) translates through to earnings per share, then I think we could be looking at a year-end P/E of around eight. Could that be an oversold over-reaction?
Superdry shares one similar problem with ASOS, and that’s falling margins. That this comes at a time when the company has been investing in new bricks-and-mortar stores adds to my concern, and a need to reduce expenditure could well put pressure on the dividend.
That’s not happened yet, and the firm does have net cash, but falling dividend cover could change that if there’s no reversal in profit trends in the coming year.
Superdry is still a ‘fad’ brand that I wouldn’t buy myself, but the stock’s low P/E multiple could make it a target for turnaround investors, especially as there are no debt problems.
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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended ASOS. The Motley Fool UK has recommended Superdry. 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.