Company in the news: ASOS

ASOS (Aim: ASC), the online-only fashion retailer, is very successful indeed. It sells its own label and branded fashion products to young people across the world. Its website gets 71 millions hits per month and has signed up 8.2 million customers.

The stock market has been very excited about ASOS’s prospects for some time. The company, having grown very quickly in the UK, is set on repeating its success in places such as America and China, while continuing to grow. This has led to projections of massive profits in the future and a share price that has exceed 100 times expected earnings.

This is the kind of crazy valuation that was placed on internet companies during the late 1990s technology bubble. Just think about this for a minute. People are buying shares where the earnings yield (profits divided by the share price) or interest rate is less than 1%.

To make money from buying the shares at these prices, you have to believe that profits will grow very quickly and that investors will continue to accept a low interest rate (or high price-to-earnings multiple). This rarely happens.

Yet it seems that ASOS is the UK’s equivalent of Amazon. Here, the argument for buying the shares is based upon very fast sales growth. Don’t worry about big profits for the moment – they will turn up eventually.

On Tuesday this week, ASOS said that it was still growing its sales very quickly, just not as quickly as analysts expected. Sales had grown by 26% during the last three months, compared to 38% in the previous three. Management blamed exchange rates and said that sales had bounced back a bit in March.

ASOS share price chartASOS will make money, but profit margins of about 6.5% will be less than expected as the company is spending more money on investment. The shares promptly fell by a fifth, but then recovered slightly.

Even so, it looks like analysts are forecasting net after-tax profit for ASOS of about £50m this year. At 5,689p, the company is currently valued at £4.75bn, or 95 times expected profits.

History tells us that very few companies are ever worth this much. This tends to be forgotten when things are going well. When expectations can’t be met, pumped-up valuations can go flat very quickly.

ASOS could still make a lot more money than it does now, but the price of its shares takes that for granted (and more), which makes them very risky. They could have a long way to fall yet.

Verdict: sell