Investors have a tendency to view stocks as typical of the sector that they operate in. Usually this makes sense, since some factors, such as the macroeconomic backdrop, affect all firms, no matter how well – or how badly – they are run.
However, when markets focus on the overall industry to the exclusion of everything else, they can overlook some excellent companies, especially if they have misunderstood the business. An interesting case in point is the retailer Watches of Switzerland (LSE: WOSG), whose shares have languished recently.
WOSG’s problem is that markets view it as just another mid-market retailer operating on the British high street. As a result, its shares have fallen by around 50% over the last 18 months. People expected its sales to stagnate as Britain’s reopening boom gave way to the cost-of-living crisis.
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However, this view misses the fact that its products – luxury watches and jewellery – mean that it in fact operates at the high end of the market, making it relatively immune to turbulent economic conditions.
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Strong relationships
It has spent a great deal of time and effort cultivating strong relationships with some of the leading Swiss brands, putting it on a par with companies selling high-end goods, such as LVMH and Hermès, which continue to prosper. Even if the economic problems do spread into the luxury market, there are long waiting lists for several of the watches that WOSG sells, so it shouldn’t suffer.
In addition to benefiting from the strong growth of the luxury market, WOSG has some interesting ideas about future expansion. Although originally focused on the UK, it has gradually expanded its presence in the US market, which now accounts for just under half of its sales.
The board hopes to grow this percentage, taking advantage of what it see as a lack of competition in America. At the same time, the group thinks that Europe is another market where it could expand its footprint in future.
Another compelling reason to be positive about Watches of Switzerland is its valuation. Despite strong double-digit growth, and a high return on capital employed (a key gauge of profitability) that has enabled it to more than quadruple its free cash flow over the past four years, it is only valued at 13.4 times 2024 earnings. This is barely more than slower-growing high-street chains such as Marks & Spencer. A more appropriate comparison would be with LVMH and Hermès, which trade on 2024 price/earnings (p/e) ratios of 24 and 51 respectively.
There are also signs that WOSG’s strong fundamentals and appetising valuation are finally being recognised by investors. While the stock is still just under a third off its 52-week highs, it has gone up by 8% over the last month and is now above its 50-day moving average. I would therefore go long at the current price of 706p at £3 per 1p. I would put a stop-loss at 400p, which would give you a total downside of £900.
