3 Lessons From ASOS plc

What can investors learn from ASOS plc’s (LON: ASC) 30% drop?

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Shareholders in ASOS (LSE: ASC) are nursing a 30% drop in the value of their shares after a profit warning blamed on the strength of sterling and “increased levels of promotional activity”, i.e. having to discount sales. The stock is down 45% since February’s highs.

I’m not a holder myself, but I can empathise. If you believe that the market is efficient, then yesterday’s price of £45 a share was just as rational as today’s £31, given the information then available. But whether an ASOS shareholder or not, there are useful lessons that can be drawn.

Lesson One: Mega-PEs are dangerous

There are high PEs, and then there are mega-PEs. Overnight, ASOS has dropped from an historic PE multiple of 90 times to around 63 times. Massive PEs go hand in hand with rapid growth: over the past five years ASOS’s sales have increased by over 50% a year. But they represent the TNT of ratings: with explosive growth potential — ASOS’s shares are still over seven times their value five years ago — but equally capable of blowing up in your face.

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Mega-PEs represent mega-expectations. That puts a huge burden on management to keep accelerating sales whilst maintaining or growing margins. Any blip is magnified into a big disappointment.

It’s something to think about when investing in any high-PE share. The market read-across has mostly hit fashion shares, but the lesson applies to shares like Ocado and ARM.

Lesson Two: First-movers don’t have all the advantages

ASOS’s rapid growth is down to it being first to bring fast copies of catwalk fashion to a mass market at cheap prices via the internet — initially in the UK and rolling out internationally. Being first-mover means it has captured market share. But it also means making the mistakes that followers can avoid. It seems ASOS has been especially hard hit by sterling’s strength because it can’t differentially price goods across markets.

A slew of internet-based fashion retailers such as Boohoo are after the same market. ABF‘s Primark does a similar job on the high street — and is experimenting with online sales. The question is, does ASOS have a sustainable competitive advantage? More generally, the same question could be asked of internet white-goods seller AO World, for example.

Lesson Three: Diversify, diversify and diversify

Highly rated companies can, and do, go on to multi-bag and enrich shareholders: think Amazon, Google, ARM etc. But survivorship bias means we tend to remember only the successes whilst, however good our stock-picking might be, there’s no sure-fire way of picking winners and losers amongst such high risk/high reward stocks.

Diversification makes sense. Theoreticians reckon 10 or so stocks can adequately diversify the risks in a portfolio but I prefer more, and if you’re a fan of stocks like these then it would pay to balance them with more mundane value-type shares.

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Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Tony owns shares in ABF but no other shares mentioned in this article. The Motley Fool has recommended shares in ASOS.

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