How not to invest in retail shares

The single worst way to predict a retailer's future

Stock market forecasting processes in action

Last week I promised you a game-changing post and here it is. I’ve discovered the single worst way to predict whether a retailer’s share price is going to go up or down. I’ve tried octopi in water tanks, monkeys throwing their own waste and even tried reading those AI-generated stock market analysis blogs. But I’ve managed to go one better than any of them.

Those of you who have been reading Moving Tribes since the beginning may remember this post:

At the margin

In it, I referenced the league table that the fine people at Retail Week produce every year summarising the Christmas Trading updates produced by many retailers.

I also spent a bit of time outlining how misleading they might be. In summary, Christmas trading updates are:

• unaudited

• cover different time periods from each other

• reflect (usually) only Like For Like sales growth with little analysis of how much margin dilution has been ‘spent’ to gain that growth

• therefore tell you nothing about underlying profit performance

• are even less useful in an inflationary environment where some LFL growth should have been inevitable.

Well, it occurred to me this week to go back and check my work. Are Christmas trading updates as unreliable as indicators of real company performance as I cynically suggested they were?

To evaluate that, I’ve taken all of the entries in the Retail Week league table with a share price (so eliminated all the privately held businesses) and compared their Christmas trading update headline LFL movement with how their shares have done in the just over 6 months since then.

You’ve guessed where this is heading. Here is the output:

So it would seem that the relationship between the exuberance of the trading update (from left to right) and the clinical reality of the share price movement (from bottom to top) is not a very strong one.

Indeed, for the mathematically minded amongst you the R-squared figure on that trend-line, which measures how close the relationship is between performance on the horizontal axis is with that on the vertical on a range between 0 and 1 is, in this case, 0.0011. In other words, so close to zero that it would be almost impossible to find anything less well correlated with share price movements than trading updates!

Why might that be? Well one answer of course is the range of reasons given in that earlier post about how misleading trading updates can be, but I think we can also see some other reasons in the detail of this chart:

• Some businesses might be seen to have responded to their poor trading very well, through cost-cutting or strategic repositioning (AO seems a good fit for this)

• Some businesses were only just beginning to show the impact of a turnaround, and so had a middle-ish trading update but have continued to go from strength to strength since (step forward M&S)

• And some are really demonstrating the point from my earlier post that it is what happens below the revenue line which really matters - consider Superdry, still on most retail observer’s lists of “I don’t know how they are still going” who published a huge 25% Christmas LFL but downgraded their profit forecast on the same day (and have downgraded again since).

In a strange sense, I find this lack of correlation quite heartening. In looking at the surprising variations between trading update and share price movements on this chart we are reminded of some core truths of business which the short term perspectives of the news cycle can sometimes obscure:

• In the end, it is profit (and cash generation) that matters most

• It is how management teams respond to the trading environment they are in that really determines whether their business is worth investing in

• For all the worries many of us have about stock market short-termism, there is a reasonable correlation between those businesses which are ‘doing the right things’ - investing in their customer propositions, renewing their offer etc - and those which are seeing share price gains in the medium term.

That said, there is plenty to think about in that chart, including (in my view), one or two retailers in the mid-table who’s shares are only going down from here, and equally one or two at the bottom which are still terrific businesses with a great future.

But for that analysis, I’ll need to dig out the octopus again.

What do you think? Feel free to share your retail stock market forecasts here, and perhaps we can revisit again in another 6 months and see how you did!