Trading: Dunelm will keep growing, here's how to play it

Covid-19 has shaken up the world of retail, creating both winners and losers. For the first 18 months it looked as if the home furnishing retailer Dunelm (LSE: DNLM) was one of the winners. Even though its shops were closed, it managed to shift quickly to online sales. It also benefited from people using the money they saved on travel and going out to improve their homes.

Between the end of March and October 2020, Dunelm’s share price nearly tripled. Even as late as last September it was still substantially above the level it was in February 2020. However, over the past year its share price has fallen by more than 40% and is now languishing well below the pre-pandemic level, even though sales are much higher.

Of course, there are rational reasons for investors to be concerned. With inflation outstripping increases in pay, households may choose to cut back on buying new furniture, or at least defer purchases until the economic situation improves.

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Dunelm’s management admits this could be a problem in the short run. Still, there are some reasons for optimism. First, the latest earnings figures suggest that, while there has been a small decline in the past three months, sales are holding up better than many people expected and are likely to come in above expectations.

Investing effectively

Management is confident that investment in digital platforms, as well as improving the quality of physical stores and expanding the range of products available, will help the company continue to win market share from rivals. Over the past year 85% of Dunelm’s sales growth has come from increasing market share, which is why it has consistently grown sales by double digits over the past two, five and ten years.

Crucially, this growth has not come at the expense of profitability. Operating margins been consistently around 10%-15% since 2016 and even rose in 2021. The company has also deployed its capital in an efficient manner, with a return on capital employed of roughly 30%. Despite investing in growth, it has consistently increased its dividend (with the exception of 2020 when it was suspended, like many other firms).

Despite this strong record, Dunelm is valued at just 11.8 times forecast 2023 earnings. The dividend yield is a compelling 5.6%. Encouraging fundamentals is one thing, but many people may still be wary about buying into a share that has fallen so much. However, there are some signs that Dunelm’s share price may have bottomed as it is now trading above its 50-day moving average. As a result, I’d suggest that you immediately go long at the current price of 878p at £3 per 1p. In this case, I’d suggest that you put the stop loss at 578p, which would give you a total downside of £900.

How my tips have fared

In the past fortnight my open long tips have put in a strong performance, with two out of the three tips rising. Telecoms firm Airtel Africa climbed from 146p to 171p, while equipment-rental company Ashtead rose from 3,785p to 4,142p. Fast-food chain Domino’s Pizza Group fell very slightly, from 276p to 275p.

The pending tips in both Hays Recruitment and sportswear retailer JD Sports rose above the levels at which you should go long on them, at 125p and 140p respectively. However, pet-supplies retailer Pets at Home and online-fashion retailer Asos still remain below the price at which you should start going long.

Overall, my long tips are making combined profits of £3,092. Unfortunately, my short tips didn’t do so well last week, with four of my six open tips rising.

Remote-medicine firm Teladoc advanced from $39.59 to $41.89, Chinese real-estate firm KE Holdings climbed from $15.10 to $15.53, and digital-currency exchange Coinbase also rose from $54 to $67. DWAC, the holding company for former US president Donald Trump’s social media venture, also increased,

from $29.45 to $31.

On the plus side, cinema chain AMC fell from $14.95 to $14.92 while online-marketing firm HubSpot also declined from $295 to $292. In total, my short tips are making a combined profit of £6,330, slightly down from £6,543 two weeks ago.

My short and long tips are making a combined overall profit of £9,635. I suggest that you close the positions in Domino’s and AMC, while cancelling the pending position in Asos. This leaves ten open tips: long positions in Airtel Africa, Ashtead, Dunelm, Hays Recruitment and JD Sports; and short positions in Teladoc, HubSpot, KE Holdings, DWAC and Coinbase.

I also suggest that you raise the stop loss on Airtel Africa to 135p (from 125p), while cutting the level at which you cover all the shorts as follows: KE Holdings to $25 (from $30); HubSpot, to $320 (from $325); Teladoc to $55 (from $60); DWAC to $45 (from $50); and Coinbase to $80 (from $90).

Trading techniques: how heatwaves affect the markets

The temperature has finally cooled down after shattering records last week, but what effect does extreme weather have on the market? Studies have shown that sunny weather is generally associated with stronger stock performance, perhaps because it makes people feel more optimistic. For example, a 2015 study by Gary Smith and Michael Zurhellen of Pomona College, California, compared the average stock returns on the US market days that were sunny (in New York) with those on cloudy days between 1948 and 2013. They found that the market did better on sunny days.

However, it appears the market is much less happy about high temperatures, which research suggests can actually hit returns. A 2019 study by Paul Griffin of the University of California, Davis; and David Lont of the University of Otago and Martien Lubberink of the Victoria University of Wellington, both in New Zealand, looked at the impact of extreme heat (as defined by the US National Oceanic and Atmospheric Administration) on share prices from 2008 to 2017. They found that the share prices of those companies that had their headquarters in the affected regions were significantly lower even 20 days after the beginning of the heatwave.

The same study also found that the declines were even bigger for particularly extreme or prolonged heatwaves, as well as those that coincided with a large amount of heat-related damage. Interestingly enough, the market doesn’t seem to be as concerned about periods of extreme cold, even if they are prolonged or destructive, as the same study found that such cold snaps had no statistically significant impact on share returns, either in a positive or a negative direction.