Burberry (LSE:BRBY) has seen its share price fall 38% since the start of the year. That would seem to put the shares firmly in value territory.
In the stock market, though, there’s no rule that whatever goes up must come down. And there’s definitely no guarantee that everything that goes down must come back up again.
Value traps
Right now, Burberry’s shares trade at a price-to-earnings (P/E) ratio of 12. That’s towards the lower end of its range over the last 10 years, but that doesn’t mean the stock is going to recover.
Burberry P/E ratio 2014-24
Created at TradingView
In general, the stock market reacts to change. And the news that will cause Burberry’s shares to move higher is the company starting to grow its earnings.
The question for investors, though, is when that will happen. If it takes too long, the opportunity cost of waiting might be too great.
At the moment, the stock has a dividend yield of just under 7%. But it would be a brave investor who banks on that being sustained if things don’t look up for the underlying business.
Earnings growth
The company’s latest earnings update didn’t offer investors much in the way of encouragement. Sales declined by 12% and operating profits fell by 34%.
Even the best businesses go through temporary downturns and investors should expect Burberry to be more cyclical than average. But there are some bigger problems that are more concerning.
The main issue, in my view, is the company’s exposure to China. It’s not so long ago that this was thought to be a good thing, but things have changed quite dramatically over the last few years.
The CEO acknowledges that demand in China is weak in general. In other words, sales in the country have slowed significantly across the industry.
This might be true, but the problem is that other businesses don’t have the same level of exposure to China as Burberry. As a result, it looks especially hard to grow earnings for the UK designer.
Will the stock recover?
I think Burberry shares will recover from these levels, but I’d be wary about buying the stock today. Without an obvious sign of earnings growth, I think there are better opportunities for investors.
Aside from a recovery in China, there are other things that could help the business. One is a reduction in interest rates easing some of the pressure on consumer budgets in the UK and the US.
Burberry operates in a difficult part of the market. It’s not a discount offering, but it also doesn’t benefit from the kind of stable demand that products for the ultra-rich enjoy.
As a result, the company is more cyclical than most. Its trench coats are iconic and demand will surely pick up eventually, but as there is no sign that this is imminent, I’m concentrating my resources elsewhere.
