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Should you pile into ASOS after today’s 10% share price jump?

These are tough times for the high street, but they’re not so easy for online retailers either. This morning 20-something fashion hub ASOS (LSE: ASC) announced an 87% drop in profits before tax to £4m, yet bizarrely, its stock is up 10% as a result. What’s going on?

Profit drop

The sharp drop in profits was due to competitive pressures in Europe, high levels of discounting and promotions, and the costs involved in its recent US warehouse launch. Retail gross margins fell 60 basis points, and CEO Nick Beighton conceded: “ASOS is capable of a lot more”.

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There was positive news in today’s interims as well, with group revenues up 14% to £1.3bn, while retail sales jumped 16% in the UK and 12% internationally. The number of active customers and orders placed also climbed and Beighton declared the group “confident of an improved performance in the second half” and said it should meet guidance for this year, which was lowered in December after a shock profit warning.

AIM-listed ASOS is nearing the end of a major capex programme, with all the cost and disruption that involves, but hopes to capture share in a market estimated at more than £220bn, Beighton added.We now have the tech platform, the infrastructure, [and] a constant conversation with our growing customer base who love our own great product.”

Fast fashion

Declining profits weren’t supposed to happen to whizzy online retailers like ASOS. Leave that to Debenhams and other lumbering bricks and mortar giants. Maybe we are all shopped out.

The stock is up because investors expect brighter times ahead, as the company should now benefit from recent investments. My colleague Rupert Hargreaves is optimistic and reckons that ASOS could blow its growth targets out of the water. Beighton is aiming to be only of only be a handful of companies with truly global scale, but ASOS will have to get there pretty snappily given today’s pricey valuation of 60.3 times forecast earnings. Expect an exciting ride, though.

AA rated

Roadside assistance and insurance provider AA (LSE: AA) has also endured a rough ride, its stock down 70% measured over two years while it recently fell out of the FTSE 250. Investors’ prime concern is debt, currently around eight times earnings, while last year it had to complete a refinancing deal, and is now using the proceeds to invest in the business.

The AA’s stock has stabilised lately and its recent full-year results to 31 January showed a small 2% rise in revenue but a sharp 32% drop in adjusted earnings per share, as well as a vicious 60% cut to the dividend.

Moving on

Personal memberships are falling although the AA is compensating by striking business-to-business deals to offer its products to customers of Lloyds Banking Group, Jaguar Land Rover, Volkswagen Group and now Admiral. It also needs to work hard to attract a younger audience, and pull away from its over-50s image.

At least the challenges are reflected in its valuation of 6.1 times forecast earnings, but I expect a few more false turns before AA is finally back on track.

Capital Gains

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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK owns shares of 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.