As the boohoo share price makes it a penny stock, I’m buying

A lot of people are used to buying things cheap from online retailer boohoo (LSE: BOO). But lately, the most striking thing on sale has been the boohoo share price. After collapsing 74% in 12 months, the company now trades as a penny share.   

Although I see risks, I do think the share price is a buying opportunity for my portfolio. Here is why.

Bull case for boohoo

A lot of things can affect a company’s share price in the short term. I think that can be seen right now with what is happening at boohoo.

Cost inflation and logistics challenges have been eating into profit margins. That is true for many retailers right now. But as boohoo sells clothes at very low prices, it has less ability to absorb cost increases than some of its competitors.

On top of that, some large investors have been selling boohoo shares even as the price has been in freefall. Fund manager Jupiter used to own almost a tenth of the company, but has recently sold half its stake.

But I see these sorts of challenges as essentially temporary in nature. In the end, I expect the company to bring its cost base in line with its business needs, even if that means raising its prices. A large shareholder cutting a stake is part and parcel of doing business as a listed company. When the short-term noise dies away, what remains is the underlying business case for boohoo. I remain positive about that.

It has a well-recognised brand and has been growing revenues fast. Last year, for example, it reported a sales increase of 41%. Its aggressive expansion in the massive US market could help sales keep growing at speed. Profits have also been increasing for a few years in a row and last year reached £93m after tax. Despite the penny share status, this is a proven, profitable business, not some digital start-up with no pathway to earnings.

Bear case for boohoo

Clearly, the company continues to have a number of critics. The business model forces it to be very competitive and allows little margin for error, due to tight profit margins. That is a risk in clothes retail, where predicting upcoming trends or weather conditions accurately can make the difference between a healthy profit and a costly warehouse of unsold stock.

It has also led to criticism about sweatshop conditions at some of the company’s suppliers. I think boohoo has been serious about engaging with these concerns. But its low-price model means legitimate complaints about labour conditions could well come back in future. As consumers show more concern about the environment, the whole fast-fashion model could be a source of reputational damage for companies including boohoo.

Why I’m buying the boohoo share price

Despite that, I have been adding boohoo shares to my portfolio lately.

I think the concerns are valid, but the markdown in the boohoo share price has been overdone. The profitable company currently trades at a price-to-earnings ratio of around 12. Given its proven high growth potential, that seems cheap to me. The next couple of years may be tough for the business, but I see long-term value for my portfolio at the current boohoo share price.

Christopher Ruane owns shares in boohoo group. The Motley Fool UK has recommended Jupiter Fund Management and boohoo group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.