Small-cap investing guru Jim Slater once said that “elephants don’t gallop,” meaning that small companies can have far more potential for share price growth than FTSE 100 giants.
But if you think that means growth investors should steer clear of the FTSE 100, just look at what’s happened to Ocado Group (LSE: OCDO) this year. After slowly declining for years, the retail technology specialist’s shares have almost trebled in value in the past 12 months.
It did take a long time to get to here, and it was almost three years after Ocado’s IPO before the share price managed to get above the flotation price and stay there. And that’s more support for my rule of thumb to never buy at an IPO.
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Sustainability
But is today’s price level sustainable? I don’t think so, at least not in the medium term. The big problem I see is that, despite having reached a market cap of £5.8bn and been propelled into the FTSE 100, Ocado is still a “jam tomorrow company” and is still valued on its hopes for big future profits.
Right now, analysts are predicting losses for this year and next, and hopes appear to be pinned on Ocado’s expansion potential. But as my Motley Fool colleague Roland Head points out, that expansion comes with serious capital investment obligations.
And seeing Ocado as a technologist rather than a groceries retailer? Wasn’t that kind of thinking behind the dotcom boom and bust? I still see Ocado as really just a different kind of retailer, but its volumes are way behind the big operators in the groceries business.
Do Ocado’s warehousing software systems warrant a £5.8bn market cap? I don’t see it.
A supermarket bargain?
I confess I’m not too taken by the UK’s listed supermarket chains either, though J Sainsbury (LSE: SBRY) shares do look reasonable value to me at the moment — at least on fundamentals.
After four years of declining earnings, caused by a number of challenges including the belt-tightening of our economic austerity and the growing competition from Lidl and Aldi, Sainsbury is expected to see flat earnings this year. And analysts have EPS growth on the cards for 2019 and 2020, albeit very modest at 1% and 3% respectively.
Dividend yields look reasonable too, with 3.3% indicated for this year, rising to 3.7% by 2020. And those payments would be close to twice covered by earnings.
On those measures, forward P/E multiples of a little over 14, in line with the FTSE 100 long-term average, look fair enough to me.
Rapid change
But what puts me off Sainsbury is that this is still a rapidly changing sector, and while Aldi and Lidl have relatively small market shares, they’re expanding fast, while the big players are struggling to avoid closing stores.
The planned merger between Sainsbury and Asda, if it goes ahead, looks set to change the groceries retail scene significantly too. And though I think it’s a good move for both parties, it is a reactive move aimed at helping offset the cost pressures of competition rather than a proactive growth move.
While I don’t think an investment in Sainsbury’s would be a disaster, I see far more attractive opportunities elsewhere in our beleaguered FTSE 100 right now.
