Questor is The Telegraph’s stockpicking column, helping you decode the markets and offering insights on where to invest for the past six decades.
Marks & Spencer shares have been a fairly obvious “buy” over recent years. The high street stalwart has gradually implemented a simple but effective strategy that aims to grow profits by improving product quality and reducing costs. In addition, its share price has generally traded on a relatively low valuation that has provided a wide margin of safety for new investors.
But deciding whether the FTSE 100 retailer is still worth buying today is a less straightforward task than it once was. Its shares have soared 147pc and outperformed the large-cap index by 132 percentage points since Questor first tipped them in May 2021. And while the company’s financial performance has significantly improved over the past few years, its rapidly rising share price has led to a rather lofty market valuation.
It now trades on a price-to-earnings (P/E) ratio of around 16.2. This is substantially higher than the figure of 9.1 at the time of our original tip and is also richer than the p/e of 13.6 that was present when we last covered the stock in April this year. It shows that there is now less scope for an upward rerating, with FTSE 100 retailers that are focused on the UK economy typically unable to command a vast premium versus the wider index.
Despite its relatively rich market valuation, there are clear catalysts that could prompt further capital gains for the Marks & Spencer share price. The company is set to be a major beneficiary of a new era of low inflation that should mean the cost of living crisis is finally brought to an end. Although the pace of price rises remains slightly above the Bank of England’s 2pc target and is expected to modestly increase in the short run, it is widely forecast to remain sufficiently low to allow the central bank to cut interest rates.
A sustained decline in Bank Rate is likely to prompt stronger employment prospects and higher wage growth. When combined with low inflation, this should equate to an increase in purchasing power among consumers. Mid-tier operators such as Marks & Spencer are likely to be major beneficiaries of this development, with shoppers likely to return from budget rivals as they become less price conscious and more interested in other factors such as product quality and customer service.
Alongside improving sales, the company’s efficiency programme should boost profitability. It generated £180m of structural cost savings in the 2024 financial year, with the company subsequently raising its five-year target from £400m to £500m. This is set to boost reinvestment, which is also being aided by an improving financial position.
The company has a net debt-to-equity ratio of 75pc, which is down from 96pc in the prior year, while net finance costs were covered a very healthy 17 times during its latest financial year.
Although its joint venture with Ocado has proved to be less successful than previously envisaged, Questor believes it still offers long-term growth potential. The proportion of UK retail sales conducted online has risen year on year over recent months, thereby resuming its longstanding pre-Covid trend, with e-commerce penetration in the grocery sector likely to further increase.
As a result of the aforementioned catalysts, Marks and Spencer is forecast to deliver double-digit earnings growth in the next two financial years. This helps to assuage concerns that the company’s market valuation is now overly generous, with its P/E ratio falling to around 13 when financial year 2026’s profit forecasts are factored in.
Of course, there is scope for trading conditions to be more challenging than the company’s earnings forecasts currently suggest. Sticky inflation could delay interest rate cuts, for example, while time lags following changes to the Bank Rate mean that the economy’s performance may prove to be more volatile than many investors currently anticipate.
That said, the company’s long-term prospects remain fundamentally sound. Its solid financial position, excellent strategy and an operating environment that will ultimately improve suggest there are further capital gains on offer.
While they may prove to be less impressive in future than those generated since our initial “buy” recommendation over three years ago, the stock nevertheless remains a worthwhile purchase that is well placed to deliver further FTSE 100 outperformance.
Questor says: buy
Ticker: MKS
Share price: 377.1p
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