Would you like to be able to quit work and live on the income from your investments?
Many of the investors I know who have achieved this admit that much of their wealth came from one or two outstandingly successful investments. Finding such opportunities isn’t easy, but today I want to look at one company I think ticks the right boxes.
In search of bargain valuations, I’ve been hunting in the unloved UK retail sector.
In my view, one of the best quality retailers in the UK is Next (LSE: NXT). It’s tempting to think of this group only in terms of its high street stores and own-branded clothes. But there’s a lot more to this business, as I’ll explain.
1. A new growth platform
Next’s catalogue operation was successful in the home delivery market long before the internet appeared. Today, the company generates more than half of its profits from its fast-growing online business.
Alongside this, Next still has a large, profitable store estate. This is backed by a sophisticated warehouse and distribution network.
Although Next’s own-brand product remains a core part of the business, the company has decided to use its infrastructure to provide an online platform for other fashion brands. Last year, the company sold more than £400m of third-party branded product online. This generated a profit of £66m — nearly 10% of group profits.
Although some of this product competes with Next’s own ranges, it’s allowing the firm to expand and generate profit from sales that would otherwise happen elsewhere. Management sees this as part of the change necessary to secure the long-term future of the business. I agree.
One advantage of the firm’s store network is that it can be used for online collections and returns, as well as sales. This gives the business an advantage over other online retailers and could help to extend the profitable life of Next’s high street stores.
2. Finance profits
About 80% of Next’s profits come from product. The remainder come from finance charges for customers who buy on credit. Last year, Next generated £121.2m of profit from its finance operations. That’s nearly 20% of the group’s total operating profit.
The finance business does sometimes make me a little nervous, as it carries regulatory and cyclical risks. But Next has a long track record in this area and has so far avoided problems.
3. Highly profitable
The final reason why I like Next is that it’s one of the most profitable retailers in the UK.
Last year, the company generated a return on capital employed of 45%. That’s an exceptional figure — it means that the firm generated £450 of operating profit for every £1,000 of capital invested in the firm. Most retailers achieve less than half this figure.
Is now the right time to buy? Highly profitable companies normally attract premium valuations. By contrast, Next stock isn’t expensive, on just 12 times forecast earnings, with a dividend yield of 3.1%.
I think that the main reason for this modest price tag is that investors are unsure how much growth this business has left in the tank. Profits are expected to be flat again this year, for the third consecutive year.
I agree that growth is a risk. But in my view, Next’s outstanding track record is enough to justify a buy rating at this price.