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This thing could put a rocket under the ASOS share price

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The ASOS (LSE: ASC) share price endured a stomach-churning crash in the spring when Covid-19 hit the markets.

The self-described online retailer for fashion-loving 20-somethings around the world saw its stock plunge by just over 70% from 11 February until mid-April. And that counts as one of the furthest drops of all during the stock market crash.

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The buoyant ASOS share price

Maybe that’s unsurprising when you consider the company has enjoyed a rich valuation for many years. Indeed, investors’ expectations of outperformance have been high regarding ASOS. So, when the world changed, many probably switched to risk-off mode and dumped everything, especially their expensive stocks. Indeed, in the early days of the pandemic, we all had little idea of how things would develop.

But, in early April, it began to emerge that shoppers were switching from high street shopping to online channels during the lockdowns. And ASOS started shooting back up. At today’s 3,510p, the share is now within a whisker of the level it was in February, before the plunge.

However, to reverse the 70% plunge, ASOS needed to climb by about 230%. That sounds a lot, but it’s only restoring the stock back to where it started. And that move seems rational to me, because earnings have been rising.

Indeed, the extra revenue being generated by shoppers migrating online is dropping to the bottom line for ASOS. The firm has also been cutting costs. And City analysts have pencilled in an impressive three-figure percentage hike in earnings for the next trading year to August 2021. And rising earnings could be the thing that puts a rocket under the share price.

Strong year-on-year profit growth

In a trading update released on 15 July, chief executive Nick Beighton said ASOS is “on track to deliver strong year-on-year profit growth and to return to positive free cash flow for the full year.” However, he also said the directors are cautious about the ongoing effects of Covid-19 on the business.

But, so far, the pandemic is boosting earnings. And earnings tend to be a big driver of share prices. Because of this, I reckon there’s potential for sentiment to drive the stock back up to its previous highs of 2018 above 7,000p.

One possible scenario is that consumers will continue to enjoy shopping with ASOS, even when coronavirus is a distant memory. I’ve heard plenty of arguments that the pandemic is hastening the switch from the high street to online channels. It’s possible that higher profits could endure for ASOS, marking a step up in the growth story.

However, analysts at Morgan Stanley urged caution last week. Their survey data suggests consumers will likely go back to in-store shopping when social distancing is relaxed. And ASOS could see a decline in revenue down the road if a vaccine becomes available.

Right now, that’s speculation. Meanwhile, the company’s forward-looking earnings multiple for the trading year to August 2021 sits just above 50. The stakes are high!

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Kevin Godbold has no position in any share mentioned. The Motley Fool UK 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.

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