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The Boohoo share price has underperformed Asos. Should I buy the stock?

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The Boohoo (LSE: BOO) share price has underperformed its peer Asos (LSE: ASC) by approximately 30% over the past 12 months. Compared to the stock’s performance over the past five years, this stands out. Indeed, shares in Boohoo have returned more than 800% over the past five years, compared to just 80% for Asos. 

Of course, an investment’s past performance should never be used as a guide to future returns. Nevertheless, in my opinion, the divergence in performance between these two online fashion retailers over the past 12 months is notable. 

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As such, I’ve been taking a closer look at the Boohoo share price recently to try and determine if it is undervalued. 

Growth potential

I’m going to evaluate these companies based on two fundamental qualities. First of all, growth.

Since 2015, Boohoo earnings have grown at a compound annual rate of 45%. Analysts project a further increase of 58% for the group’s current financial year. By comparison, Asos earnings have grown at a compound annual rate of around 23% since 2015. For fiscal 2021, the City expects the organisation to report earnings growth of around 7%. 

As I’ve said, it’s never sensible to rely on any business’s past growth track record to evaluate its future potential. There’ll always be factors that have existed in the past which may not be present in the future. Nevertheless, I think historical growth rates give me great insight into how to well a company is run and its potential market opportunity.

For example, when comparing Boohoo and Asos, it’s clear the former has been able to grow at twice the rate of the latter. That can’t be down to accident. I think it suggests Boohoo is better at driving customer to its websites and convincing them to buy.

So, while the company’s stratospheric growth rate is unlikely to continue, I think the firm’s management has the skills required to develop the business. With Asos, I’m not so sure. 

Boohoo share price valuation 

That said, Asos looks cheaper. Based on a multiple of earnings (P/E), the Boohoo share price is approximately 28% more expensive. That seems to me to be about right, considering the group’s growth rate compared to Asos over the past five years. 

Still, one thing that worries me is Boohoo’s valuation. The stock is dealing at a high P/E of 44. That suggests the market is expecting a lot from the business. Unfortunately, it may not deliver. The world of fast fashion is brutal. Even successful companies like Boohoo can find themselves struggling after a rapid change in fortunes.

The Arcadia Group is a great example. Once one of the UK largest physical retail organisations, it’s now bankrupt, and competitors like Boohoo and Asos are dividing up its remains. One day these businesses may find themselves in the same position.

That’s why I’m concerned about Boohoo’s high valuation. If the company continues to rack up an annual earnings growth rate of 40%+, a P/E of 44 may be sustainable. But if growth slows, it may not be.

And with that in mind, I’m not a buyer of Boohoo shares at current levels. The challenges of operating in the fashion industry suggest to me that paying a high price for a business may not be the best decision.

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended ASOS and boohoo group. 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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