Next – A good buy at a bad price

I’m always keen to write about the companies that make up the portfolio, for two reasons.  One, it may help readers understand a trade decision (for right or wrong), and two, it helps me justify my decision to make that trade.  Rather than start with a success, I think it’s more appropriate to start with a mistake, therefore today’s topic of rumination will be Next (NXT).

Next

My initial interest in Next came though a Peter Lynch-esque “go with what you know” focus on a clothing brand I often purchase from.  The majority of my suits and shirts come from Next and therefore I’m happy they know what they’re doing (some of their furniture is great too, but a bit out of my price range).

But buying shares in a company you like only works if that company is well-run and profitable.  You HAVE to dig deeper, and so that’s what I did.

The Numbers

 2007-012008-012009-012010-012011-012012-012013-012014-012015-012016-01
Rev3,2843,3293,2723,4073,2973,4413,5633,7404,0004,176
Gross Margin %27.828.527.829.329.330.431.633.233.634.8
Op Income508537478529566601695722812867
Op Margin %15.516.114.615.617.217.519.519.320.320.8
Net Income332354302364401474508553634666
EPS1.441.661.551.862.172.753.113.564.184.43
Dividends0.460.180.550.560.720.8911.221.431.53
Shares (Mil)229213194196185172163159155154

Next has almost all the hallmarks of a well-run company, with financial metrics that I love.  Operating and net income had grown in 9 of the past 10 years, as had Earnings Per Share and dividend payouts.  Margins, both gross and net had been increasing, and the company had been buying back shares at a hefty pace.  All in all, lots of meaty goodness.

All the while, Next also had figures for return on equity and invested capital that competitors could only dream of.  Ted Baker?  Not even close.  Marks & Spencer?  Forget about it.

Next are also cash-flow positive, returning 630m last year.  And as we know, a company generating a lot of free cash has many more opportunities than one that has to invest heavily just to keep up.

But…this all sounds great

At this point you may be thinking “well, I’m not seeing the downside here”, and that’s a fair argument.  A company making lots of money, and using that money to buy back it’s shares to increase value for its shareholders.  Sounds great, and ultimately I believe is the reason I became a little blinkered.  Reading their 2015 annual report, I noticed this:

We will continue to undertake buybacks but only when it would give an effective return on the cash expended of at least 8%.

This is what I like to see.  A company with a STRATEGY for buying back shares.  Too often you see businesses buy back shares without setting out a plan, and when their share price is above that of their intrinsic value.  Rather than creating value for shareholders, they’re destroying it.
So this was a big plus for me, and I wanted in.  I ignored the level of debt on the balance sheet, and that their debt to equity ratio was above 3.  I assumed these stellar results and the efficient management of capital would continue, and so I placed my order.

My mistake

Take a look at the five-year chart for Next:

NextSource: Google Finance

Guess where I bought in.  Yup, well done me.

So what was my mistake?  Do I believe Next is fundamentally an excellently run company?  Of course.  But I paid too much for it.

It was even in the very same annual report mentioned earlier:

The Company maintains its 8% Equivalent Rate of Return (pre-tax) investment hurdle for share buybacks. At the mid-point of guidance issued in this report, our share price limit is £68.27.

I paid close to £80.00 per share when I placed my trade, at a point when Next was trading at over 18 times earnings (compared to the far more reasonable 12 currently).  Next isn’t a high growth company, it doesn’t deserve to trade at 18 times earnings.

Conclusion

It is all too easy to become blinkered when looking at a potential investment.  My own personal clothing preference biased me somewhat, and I became fixated on one small element of the overall picture.  I should have taken a step back and considered everything, and been in less of a rush!  More often than not, a company you like the look of WILL be better value at some point.  Don’t just dive in because you HAVE to be in right-now.  You’ll pay the price.

Am I staying in?  You betcha.  It’s just gonna take me a little longer to make my money.

 

Happy investing!

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