One thing Ive noticed about the share-price charts of fast-growing firms such as ASOS (LSE: ASC) is that an exponential peak often occurs in the first phase of the companys stock-market life.
This first peak is nearly always associated with the story getting out and achieving wide acceptance by investing believers. Impressive growth numbers often drive the ever-accelerating rise of such firms share prices. However, the turbo-charging effect of speculation drives valuations up, thrusting the share prices into cheek-wobbling velocity.
Inevitably, the natural laws of friction assert themselves in the end, and something happens to reverse the share-price direction.
The second phase
With ASOS, the online fashion retailer to 20-odd year-olds, that something happened in 2014. Shares that stood at 7000p in January, trade at about 1971p today.
General stock-market weakness combined with interim results showing slight margin slippage to kick-off the ASOS share-price descent. Just as momentum took the shares up, it took them down as 2014 rolled out. A fire in the firms distribution depot hasnt helped sentiment and neither have warnings about reduced forward margins thanks to investment in operations and pricing.
So, with the shares down, and possibly still falling, we begin the second phase of stock market life for ASOS. This is the phase where reality sets in. Instead of the firms potential driving the share price, we seem likely to see pragmatic valuation of forward expectations. ASOS will work through the challenges of business growth and the share price will probably appreciate in line with the rate of forward profit appreciation.
The second phase will no doubt turn out to be a gentler ride for ASOS investors, and it seems unlikely that the firms P/E rating will return to previous dizzy heights.
Have we missed the boat with ASOS?
Catching the first-phase wave with growth companies can be a thrilling ride, but we need to wear a parachute and jump off at the first sign of share-price reversal. Otherwise, theres a good chance of losing all the previous gains, or worse, showing a loss on the investment.
Timing an investment in the second phase can be just as potentially lucrative, but the timescale will likely be longer. Make no mistake about thisASOSs business is still growing like crazy. Last months trading statement trumpeted sales up 27% over this time last year, and around 60% of turnover comes from abroad, adding clout to the firms aspiration to become the number one fashion destination for 20-somethings globally.
Yet growing pains can be hard to sooth when expanding so fast, and the firms 5.3% net margin performance last year leaves little wiggle room for strategic error. Thats why investors watch the firms margin performance so intently, and its why I think investor total returns will proceed at a slower pace in this second stock market phase.
So when to invest?
I think ASOS is an interesting investment proposition right now, but timing the jump into the shares takes care. Firstly, we need to be sure the share price decline is finished. Technical analysis is at its strongest in these types of situations because it measures sentiment. Sentiment drove the shares up, and the share-price chart will tell us when sentiment has finished driving the shares down. Id wait for a clear bottom and a switch to a new uptrend.
Secondly, we need to look for a pragmatic valuation rather than a wild and optimistic one. At the moment, the forward P/E rating is running at about 43 for 2015, yet City forecasters expect earnings to grow just 14% that year.
Right now, the valuation looks high and theres no sign of a share-price trend reversal. To me, ASOS shares look unattractive for the time being.
ASOS still has a great business but the shares look risky, so I’m looking at a firm with growth offered at a reasonable valuation, and which has been identified as The Motley Fool’s Top Growth Share for 2014 and beyond by our small-cap specialist.
When growth potential meets a modest valuation, the attraction for investors like me magnifies, as in the case of this company.
You can run your own analysis over the firm to see if it could boost your portfolio returns by downloading the Fool’s report, which is free but time-limited. Click here.
Kevin Godbold has no position in any shares mentioned. The Motley Fool UK owns shares of ASOS. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.