ASOS, to quote a well worn phrase, took one hell of a beating on Thursday, the share price falling 40% at one stage after it warned profits and margins would not meet market expectations. Ahead of Thursday's announcement, the stock was trading on approximately 60 times its forecast earnings per share. To give one an idea of how expensive ASOS is in terms of valuation, the FTSE 100 trades on roughly 13x its forecast earnings. The expectation of a high multiple investment is that the investor pays now for forecast superior earnings growth. High multiple investments can be very profitable if those expectations are met, as has been the case for ASOS, the shares have risen sharply in the past three years, until Thursday that is.
The problem comes when the growth fails to meet expectations. ASOS compound annual earnings growth rate has been about 32% over the past 5 years, hence the high valuation. Earnings growth for the FTSE 100 is traditionally about 7% per annum. Company analysts and investors often fall in love with a high growth stock believing that growth is sustainable forever and hence continue to pay high multiples, this is rarely the case. The trouble is when the growth fails to meet expectations, the shares get hit from 2 angles. Firstly, the share price needs to adjust for the worse than expected earnings announced, and secondly for the lower growth expectations going forward, leading to the sharp fall as the share price will adjust almost immediately. After Thursday's announcement, no earnings growth for next year is expected, and hopes will be moderated for the years ahead. High growth stocks can offer high profits, but caveat emptor, when the growth falters hard earned gains can be quickly lost.
One cannot finish the blog without commenting on the outcome of the ECB meeting. The measures announced were well covered by the press, forcing banks to pay to deposit cash with the ECB, cutting base rates to 15bp and extending the Long term refinancing operation (LTRO) to €400bn. As usual at the post announcement comments Mario Draghi dropped a carrot to investors suggesting today's announcement was the beginning and that the ECB had other measures available. When quizzed on this point, he once again became defensive and looked uncomfortable. The verdict on the ECB chair was given by the market. Traditionally, one would expect longer dated bond yields to rise when a central bank introduces looser monetary policies, as growth expectations should increase along with the inflation outlook, eventually leading to higher interest rates. That was not the case today as German bund yields fell, as did peripheral bond yields. The euro did fall against the US dollar, but only marginally, while the FTSE eurostoxx 300 was largely unmoved. The additional measures that Mario Draghi and the ECB promise will need to be introduced, it is just a question of when. Our long held opinion is this will be just about the time the Federal Reserve finally finish tapering its bond purchase program.