Finding deep value in the stock market isn’t as easy as it might seem. After all, the last thing I want is to buy at a low valuation and have the price plunge even further. When we investors get caught at the bottom, it’s called a ‘value trap’.
Trap or triumph?
Many readers will know Ocado (LSE:OCDO) as one of the most popular home grocery delivery services in the UK. As a company, it’s growing its revenues exceptionally well, but it’s struggling to turn this into reliable net income. It has:
- A three-year annual revenue growth rate of 8.8%.
- A three-year annual earnings per share decline rate of 27.1%.
In my opinion, it takes a real expert to make an investment in a company like this successful. In addition, even armed with knowledge about Ocado’s future operational strategy, I’d still be taking on a lot of risk. That’s because there are a multitude of variables, including high development costs, intense competition, and operational challenges, which could prevent the company from achieving profitability later on.
However, if I were to buy in at the present price-to-sales ratio of roughly 1, I could be in for huge gains if the company can stabilise its profits effectively.
Ocado’s profitability strategy
Management clearly knows what it has to do because it’s implementing a multi-layered strategy to drive home earnings.
Part of this includes automated warehouses, which use robotics and AI to reduce operational costs. I think this is one area where the business should be able to boost its margins quite significantly over the long term. That’s if management executes its plan well.
Also, the firm licenses its Ocado Smart Platform to international grocery retailers. This provides its clients with online grocery solutions and generates a clever stream of recurring revenue.
It’s a very tough game
However, the company is also expanding overseas, now with roughly 13.5% of its operating revenue from markets outside the UK. While this is good for its top line, given the steep decline in earnings, I think it might be wise for management to focus on profitability domestically first. In my opinion, growth is good, but without profitability, it’s not worth its salt.
The current predicament Ocado is in makes me think of Tesla. While I don’t agree with everything about Elon Musk’s business strategy, his focus on profitability by streamlining operations has driven significant profits. Ocado’s management could take a leaf out of Musk’s book by improving efficiency.
It’s too risky
In my opinion, going for these make-or-break investments is simply too risky. I prefer the slow, steady, stable and reliable opportunities. For example, in my opinion, Alphabet shares offer great value for money at the moment and are potentially 17.5% undervalued. What’s more, I can see Alphabet’s AI bets delivering big growth over the long term for its shareholders.
Therefore, while I wish Ocado the best and can see a bright future for it if it knuckles down on efficiency and profitability, I can’t take the risk with my own money at this time. The shares are significantly undervalued right now if the firm’s earnings turn positive in the future. However, the big problem is that it’s an if, not a when.
This post was originally published on Motley Fool
