Next: the pick of the high street

Many UK retailers are in dire trouble, but Next is beating expectations, says Matthew Partridge.

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Many UK retailers are in dire trouble, but Next is beating expectations.

It's been a tough time for the British high street recently. Higher import prices are pushing up costs, while economic uncertainty could potentially hit demand. And that's before worrying about the real elephant in the room: the shift from bricks and mortar to online trading. Even five years ago retailers could kid themselves that the ability to browse clothes in person was something that no internet retailer could provide.

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Sadly for them, all that meant was that people browsed the goods in person in their stores, only to buy them online. Indeed, the ubiquity of smartphones means you don't even need to wait until you get home to place your order.

Unable to adapt to the new environment, several retail dinosaurs have recently perished or are in trouble. BHS went bust spectacularly last year, while Carpetright, New Look and House of Fraser have been forced to enter into voluntary agreements, which have seen them close scores of shops up and down the country, shedding thousands of jobs. Debenhams is also struggling after recent disappointing trading figures.

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An encouraging update

Still, even in a troubled sector it is possible to find companies that are thriving. Several weeks ago clothing chain Next surprised analysts when its latest figures showed that it had largely managed to sidestep the collapse in sales that the extremely harsh winter brought for retailers.

The firm's sales for the first quarter of this year were up by 6% on the same period a year ago. An unusual weak spell at the start of 2017 made that comparison a bit more flattering than it really is but sales were still 2.1% higher than the much stronger first quarter of 2016.

If you look at longer-term performance, Next has grown its profits by an average of nearly 9% a year over the last six years. At the same time it has managed to maintain an operating margin of around 20% and has a return on invested capital of nearly 40%.

Staying ahead of trouble

Part of this is due to its foresight in building up its online arm: all that first-quarter sales growth came from online sales, with store sales shrinking. However, it has also been taking steps to lower its costs, by downsizing and sub-letting those shops that are no longer paying their way. The management is also smart enough to realise the demise of competitors means retailers now have the upper hand with landlords, and the company has been renegotiating leases.

Despite its leading position in the retail sector and the strong performance of Next's shares over the last six months, the firm still trades at a reasonable 14.3 times earnings. This should fall to 13.5 times by 2020. I'd suggest that you buy Next shares at 5,946p at IG's minimum of £1 per 1p. In this case, I'd recommend that you put a stop-loss at 5,000p, giving you a downside of £946.

How my tips have fared

The last four weeks haven't been particularly profitable for this column, with seven out of our eight open positions moving against us. IG Group has fallen to 848p (from 870p), Greene King is now at 556p (previously 604p), Micron's shares are at $51.48 (down from $59) Redrow has gone down to 522p (from 601p), while even Wizz Air has fallen slightly to £35.38 (compared with £35.60 when I originally tipped it). This has had a knock-on effect on profits. Redrow is now £352 in the red, and the combined paper profits on the long positions have fallen from £1,425 to £663.

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The shorts haven't done terribly well either. The S&P 500 rose to over 2,775 in mid-June. Although it has subsequently fallen back, this meant that trade was automatically closed out by the stop-loss, absorbing £480 in losses. Despite its continued production woes, Tesla is still doing well, trading at $310.86, which means that the position is losing £111. The only bright spot is bitcoin, which is now at $6,548, making us paper profits of £1,169. Overall, our remaining short positions are making a paper profit of £1,058, although the losses on the S&P 500 trade mean that the closed positions have made a cumulative loss of £77.

We've now been long IG Group for over a year, and Micron for nearly six months. They haven't done much over the past few months (or in Micron's case at all), so I'm contemplating closing both positions. However, for the moment I'm going to suggest that you merely tighten the stop-losses on these so if they fall significantly more we'll sell them. Specifically, I'm going to suggest that the stop-losses on IG Group and Micron increase to 775p and $39 respectively. I'm also going to close the bitcoin short position if it rises to above $9,000.

Trading techniques Dow Theory

Dow Theory is a trend-following approach developed by Charles Dow, the first editor of The Wall Street Journal, and later refined by his successor, William Peter Hamilton. Like other trend-following systems, it involves buying when the market is rising and selling when it is falling. The big twist is you should only buy (or go short) when both the wider market and the Dow Jones Transportation index (a sub index that covers transport stocks) are going in the same direction. A divergence between the two is a sign that the trend may be about to change.

The rationale behind this strategy is that transportation activity is a leading indicator of economic activity. For example, if firms see a recession on the horizon, they will cut down shipments of goods and raw materials and seek to draw down existing stocks. Similarly, if the economy is starting to recover they will begin ordering more goods and raw materials. This means that transportation stocks tend to move ahead of those in the wider economy.

One problem with this theory today is that in a service economy the relationship between transportation and wider economic activity may be less clear. More broadly, Dow Theory is often ambiguous, with many Dow Theorists disagreeing about when exactly you should buy and sell. Still, there is some evidence that it can be a useful trading tool.

A 1998 paper by Stephen Brown of New York University found that using Dow Theory to time your trades can cut the risk of investing compared with buy and hold without hitting returns, meaning that it did better on a risk-adjusted basis. Between 1930 and 1997 it also beat the market in absolute terms.

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