The Burberry (LSE:BRBY) share price recently hit its lowest level since 2010. Down 68% in a year, the luxury fashion giant has seen a swift implosion that has seen some investors panic. On the other hand, I know some who’ve bought the stock, with the thinking that this storm will blow over. I don’t own any shares in the firm, but when mulling it over here are some points that I think need to be flagged up.
Problems not just with demand
Burberry is a global brand, with Asia being a key market. At a practical level, this means it receives money in a variety of different currencies. It then sells these currencies and buys British pounds. This is for operating expenses here in the UK and general accounting purposes.
In the July trading update, it flagged up “a currency headwind of c.£55m to revenue and c.£20m to operating profit.” This is because the British pound has strengthened in value recently. According to some currency forecasters, it could continue to gain in value over the next year. This could be a real headache for Burberry going forward.
So, on top of weaker demand, it could stand to suffer to the tune of tens of millions of pounds simply due to exchange rates. Therefore, it’s key for me to remember that there are various elements that go into a business making either a profit or a loss. This then has an impact on the share price.
Assessing actual value
There’s a big difference between price and value. It’s true that the stock is currently at the lowest level for well over a decade. But this doesn’t automatically mean that the company is an undervalued bargain.
For example, when using the adjusted earnings per share figure from the latest financial year, I can get a feel for the value using the current share price. This is known as the price-to-earnings ratio. Usually, a ratio of 10 is deemed to be a fair value.
The ratio for Burberry at the moment is 9.71. So even with the sharp share price fall, I wouldn’t say that it’s undervalued. Investors (myself included) need to make sure that they don’t miss out on noting down changes in value versus changes in price.
Of course, this is a backward looking indicator as it uses the earnings from the past. If for some reason the firm suddenly posted a sharp spike in profits, then it would be undervalued at the current share price.
Bringing it all together
Based on my above research, I think it’s too risky for me to consider buying Burberry shares right now. I’m not writing off the business completely though. It has a proud track record, and clearly makes products that people want to buy. With a new CEO and a pivot in direction, things could get back on track over the next year.
At that point, I’m open to buying the stock. But as it stands, I don’t see any positive sparks that suggest an imminent end to the share price fall.
This post was originally published on Motley Fool
