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The AO share price is up 250%. Here’s what I’d do now

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The AO World (LSE: AO) share price has risen by 250% so far this year. Yesterday, AO shares rose by 30% in a single day.

In this article I’ll explain what’s happened at the online electrical retailer. I’ll also explain what I think shareholders and potential buyers should do now.

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A lockdown winner

This year’s lockdown and work-from-home policies have had a brutal impact on some businesses. But for others, they’ve created an incredible surge of demand. AO World appears to be one of the winners.

On Thursday, the company said that sales for the six months to 30 September rose by 57% to £715m, compared to the same period last year. UK sales rose by 54%, while sales from the group’s smaller business in Germany rose by 83%.

These are amazing results, but I think it’s worth looking at what the company didn’t say in yesterday’s update.

What about profits?

AO sales have grown strongly in recent years, but the company has struggled to make any real profits. Will that change in 2020–21? I’m not sure.

Thursday’s trading update didn’t include any mention of upgraded profit guidance for the current year. This suggests to me that AO’s historically low profit margins haven’t improved much.

Indeed, the only mention of profit I could find related to Germany. AO said that it expected the German business to turn a full-year profit during the 2021–22 financial year. In other words, not until next year.

Of course, all retailers have experienced extra costs this year. I’d imagine that handling a huge surge in demand while dealing with COVID-19 safety issues has not been easy. But I’m still struggling to get comfortable with the AO story.

The AO share price looks too high to me

Legendary US investor Warren Buffett once said that “you pay a very high price in the stock market for a cheery consensus”. I think that’s the case here.

AO World shares now trade on about 38 times forecast earnings, giving the group a market cap of £1.4bn. To put this in context, AO’s much larger rival Dixons Carphone trades on just 10 times forecast earnings. Dixons’ sales have also strongly risen this year. Historically it’s been much more profitable than AO World.

AO World says that it believes appliance sales have made a permanent shift online and that this will support future growth. Perhaps. But AO still needs to make money. So far it hasn’t really done this.

I’m also concerned that AO is reporting an increase in contract cancellations in its mobile phone business, due to changing customer habits. To me, this sounds similar to problems reported by Dixons Carphone. If I’m right, then this could be an expensive headache for AO.

I have a lot respect for what AO founder and CEO John Roberts has achieved. But as an investment, I don’t see the appeal. Until I see evidence that AO is making real, cash profits, I’ll be staying away. At current levels, I’d rate the stock as no more than a hold.

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Roland Head 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.

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