Early last month, when the shares stood at 1971p, I said that the online fashion-clothing retailer ASOS (LSE: ASC) was an interesting investment proposition. However, I thought that timing the jump into the shares would be difficult.
Back then, the share price was falling, and I thought we needed to be sure the decline had finished. I argued that sentiment drove the shares up to their peak of around 7000p, and the share-price chart would tell us when sentiment had finished driving the shares down.
Right now, the shares change hands at 2497p, up 27% from a month or so ago, so I think we’ve seen the awaited change in sentiment.
What about valuation?
My second hurdle was the need to look for a pragmatic valuation rather than a wild and optimistic one before investing. So where are we with that?
The news on that is far less clear. A month ago, at 1971p, the forward P/E rating sat at about 43 for 2015, and City forecasters were expecting earnings to grow just 14% that year.
Now, at 2497p, the forward P/E rating is running at about 57 for 2015, with City analysts predicting a 2% decline in earnings per share. So the valuation situation has deteriorated thanks to the share price going up so quickly and so far, and thanks also to analysts lowering their profit forecasts.
The outlook statement of the recent full-year results report explains why forward expectations have cooled. ASOS expects to make what it calls ‘significant’ investments in its international pricing and market proposition, as well as continuing to invest in logistics infrastructure and technology platforms. Profit will, therefore, be similar to that achieved during 2014 in the year ahead.
Yet, before achieving growth, firms must invest for growth and that’s exactly what ASOS is doing. The directors reckon the company’s investment programme is building a platform to grow annual sales to £2.5bn — a significant jump from the £975 million or so the firm posted for year to August 2014.
Explosive growth potential
It seems a case of short-term pain for long-term gain. On the one hand, prospects for immediate earnings growth seem stymied by the firm’s investment programme. On the other hand, optimistic directors see potential to increase sales by more than 150% in the medium to longer term.
The situation divides City analysts following the company. One firm of analysts has a target share price of 4450p for ASOS and another has a target of 1400p. Potentially, both could be right if ASOS shares fall on valuation concerns before rising as better earnings come through in the years ahead.
Right now, with the ASOS share price waggling between the two extremes, valuation and investor sentiment seem set to fight it out until the firm’s earnings start to rise. My conclusion is that we should expect further share price volatility, which could present opportunity to buy on the dips if we believe the ASOS story and can digest the valuation.
ASOS’s potential to detonate explosive earnings growth in the medium term makes for an intriguing investment proposition, despite the firm’s high valuation.