Why Wm. Morrison Supermarkets plc Is On My Watch List

There are no points for original ideas in investing. It only matters if your ideas are any good or not. The proof of that shows in your returns.

It isn’t any secret — backed by many academic studies — that dividend stocks outperform the market over the long term. When stock prices fail to reward — as they have done this year, with the FTSE 100 declining 2% — dividends give investors a regular income stream and, most importantly, a reason to stay invested.

Day to day the market has a 50% chance of moving up or down, but a smart investor — with a time horizon of 20 years or more — will at worst see low single-digit upside on a diversified share portfolio.

All the more reason to hug your income shares.   

morrisonsWe’re in a fierce bear market for the UK’s supermarkets. Morrisons (LSE: MRW) (NASDAQOTH: MRWSY.US), the number four contender, has lost 35% of its value in 2014. In August shares of the iconic retailer sunk to a five-year low. There’s nothing to suggest the shares won’t get cheaper, with a skittish market stampeding for the exits after each new trading statement.

Should we generally pay any attention to markets? I’m interested in buying great companies, and don’t especially care what anybody else is doing — except in one instance. There’s money to be made when a great company trades below its fair value, so my attention is piqued when I believe investors may be panicking.

The problem is that it’s not just investors who have hit the panic button. Morrisons’ management initiated a price war, but sales have yet to pick up. Like-for-like turnover fell 5% in the half year. “We’re lowering prices in a very difficult market. It’s going to take time,” the firm said. 

It isn’t that Morrisons needs to compete directly on price with the likes of Aldi and Lidl. The offering at Morrisons is far superior, with more choice and an emphasis on fresh produce. It  comes down to striking a balance between sales and profitability, and Morrisons has yet to find the right price level.

The economy showed some encouraging green shoots in 2013, with nearly half of consumers saying they felt positive about their finances. However, there’s a significant economic divide between the south of the UK and the north — the latter being Morrisons homeland.

Will consumers return to Morrisons’ stores when economic growth spreads north? The Warren Buffett quote, “If you wait for the robins, spring will be over” resonates here.

Although the +7% dividend yield may raise alarm bells, the business remains highly cash generative, and there should be sufficient cover. But this isn’t an investment without considerable risk, which means there’s potential for a higher payoff for turnaround investors.

I’m yet to decide whether Morrisons is worth a punt. Meanwhile, an attractive small cap opportunity has caught my eye. The Motley Fool's lead smaller companies analyst has discovered a £250m hidden gem which could double profits within the next four years.

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Mark Stones has no position in any shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.