Until last week, ASOS (LSE: ASC) held the enviable title of being the largest and one of the most successful businesses on AIM. The company was so successful that investors have been willing to pay more than 100 times forward earnings to get their hands on the stock. At its peak in 2014, the shares were trading at a P/E of 145.
Unfortunately, last week the stock crashed back to earth when it issued a shock profit warning. More than £1.3bn was wiped off the company’s market capitalisation following the advice that it now expects sales growth of 15% for the year to August 2019, instead of the 20-25% management had previously forecast.
Furthermore, the company now expects its adjusted profit margin for the current financial year to be just 2%, that’s down around 50% year-on-year.
ASOS’s trading update was full of worrying numbers, not just for the company and its investors, but for the rest of the retail sector as well.
Even though sales increased by 14% for the three months to the end of November, and the average basket size rose 3%, the average selling price fell 6%, and the average basket value declined 3%.
Management told investors that the retailer experienced a “significant deterioration in the important trading month of November,” echoing comments from Sports Direct founder Mike Ashley, who only a few days before the update warned that 2018’s Christmas shopping period had been so bad for retailers it would “literally smash them to pieces.“
It’s no surprise that as shares in ASOS slumped following its profit warning, shares in other retailers declined in sympathy. FTSE 100 retailer Next (LSE: NXT) was particularly badly affected. The question is, will Next be forced to issue a similar dour trading update?
Is Next immune?
This question is difficult to answer. Next isn’t entirely immune from retail sector trends, but the company has outperformed expectations over the past 12 months.
Heading into its current 2019 financial year, analysts were expecting the firm to tread water. However, after several upbeat trading updates that have come in better than expected, the City is now expecting a small increase in earnings per share for the year of 4%.
Even if the Christmas trading period does disappoint, I don’t think Next’s shareholders are in for the same kind of roller-coaster ride as ASOS’s experienced. The big difference between these two investments is valuation.
Before last week’s trading update, shares in ASOS were trading at a P/E of 35, reflecting investors’ optimism towards the business. To maintain this multiple, the company would have had to continue to grow at a double-digit rate for the foreseeable future, without any trip-ups. In comparison today, shares in Next are trading at a forward P/E of just 9.5, which tells me that the market isn’t really expecting much from the business anyway.
With this being a case, I reckon Next is unlikely to become the next ASOS. The company may issue a poor trading update after Christmas but, unlike ASOS, it doesn’t have to shoot the lights out to impress investors.
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Rupert Hargreaves owns shares in Next. The Motley Fool UK owns shares of and has recommended ASOS. 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.