ASC.L (ASOS) released its trading statement for the 3 months ended 31 May 2014 (http://is.gd/zIkEhJ). Group revenues were up 34% on a constant exchange basis. This is excellent, of course, but the company reduced its EBIT margin guidance to c.4.5% from c.6.5%. This factor seems to have sent the share price into a tailspin – down 31% at the time of writing.
Readers may recall that I actually did a valuation for ASC back in late March (http://is.gd/YUTGXw), valuing it at £20 a share. It will be interesting to revisit my valuation. I see that in my valuation I had noted that ASC had suprisingly small EBIT margins, and tapered them down to 5% over 10 years. I clearly had a sense that I expected EBIT margins to decline, and I’m having difficulty deciding if I had been too conservative in estimating the declines, or whether the reduced EBIT margin guidance by the company is more of a one-off, and I should leave things more or less as they are.
Worth noting is that valuations done by DCF tend to be fairly stable. There are shifts, to be sure, but they are usually much more stable in their outputs than share prices which, as we have seen, can be all over the place.
There are some lessons to be learnt from the share price tumble today. First, valuation matters, and the key is patience. There will often be another opportinity to buy at a much more reasonable price. Share prices are driven by sentiment, which can be whimsical. It is better to be on the right side of sentiment – by which I mean the contrarian side – provided it’s not cheap just because it’s junk. Another point that needs raising is this: what the hell were analysts thinking when they gave the company valuations of £72 per share an upwards? It all looks too stupid in hindsight. In my valuation model – which in itself is now looking to optimistic – I didn’t get anywhere near £72. I recall, not all that long ago, that some AAA-rated fund manager (don’t quote me, but I think it was either the venerable Harry Nimmo or Nigel Thomas) who said that these kinds of companies often look overvalued, but ultimately justify their valuations. . I remember thinking at the time that that is a very dangerous blanket statement, as you are effectively saying that no price, no matter how outrageous, is too much to pay for a good company. The problem is, without doing a valuation – which is admittedly subject to all manner of uncertainties – you just have no idea whether what you are paying is an acceptable price or not.
I think we should also be very careful of technical analysis. It often gives the mood of the moment, but it wont tell you when the mood will change, or how the price will react to fundamentals. As we have seen today, fundamentals matter, so basing investment decisions based purely on technicals is a potentially dangerous strategy.
Having said that, I did blog in late April stating that ASC was technically oversold and “might” rally (http://is.gd/SM8gsz). Let’s take a look an interesting chart that I have taken from Stockopedia:
I wrote the blog entry on 30 April, when ASC was at 4236p, and noted that there was a death cross at that point. I therefore speculated that a rally could well be on the cards. What I didn’t note at the time was that the shares were also oversold on RSI, which further supports the idea of a rally.
As it turned out, the decline hadn’t completed at that point, and you would have been in a losing position all the way down to about 3800p. Painful, but the share price did rebound to around 4500p in late May, so you could have made money if you had held on for about a month. I was proposing a relatively short-term trade: a few days to maybe 2 weeks. In fact, the timeframe turned out to be more like 3-4 weeks. It’s a matter of opinion as to whether I would have had the courage of my convictions to stay in the trade, or cut my losses and run. The more probable course of events would have been that I would have concluded that I had made a mistake, and sold out at a loss.
One point is did make was: “The trick would be spot the end of the rally as a place to dump. I’d look for the momentum in the rally, assuming one occurs, to peter out.” I think a clear signal in this regards was given towards the end of May. The share price had started to plateau. Rallies that plateau, or more likely, start going down again, should be taken as your signal that the trade is done and you need to get out. Anything is possible, of course. The shares could have gone to rally much higher, and even make a full recovery. But that’s not the way my proposed trading strategy worked. What I would have expected is that once the share price was apparently stalling when it reached 4500p, it would resume its downward momentum.
What actually happened was generally similar, but departed somewhat from what I was expecting. Firstly, I wasn’t really expecting a plateau lasting around 2 weeks, I was expecting a fairly quick resumption of downward momentum. I definitely was not expecting the calamatous fall that we saw today. I thought we would see a series of lower highs and lower lows – i.e. bulls which buy the dips, only to see subsequent rallies lose energy.
Where do I think we are now? Well, the upward momentum is well and truly dead, and the market is becoming much more cognizant of the fact valuations were too high. It seems, in my opinion, that the market will increasingly think that a £20 share price is a possibility, and behave accordingly. As more people become burnt, more money will be taken off the table. So my prediction is as before: a series of lower highs and lower lows until we reach £20; where the situation should be re-evaluated. Please remember, though, that I am a complete newbie at technical analysis, so you definitely shouldn’t place any emphasis on what I think.
Update 05-Jun-2014: I just noted that on 21 May 2014, Barclays Capital reiterated their overweight recommendation, with a target price of 8000p. Truly eye-watering.