2022 was not a successful year in the market for investors who owned growth shares. Fear and uncertainty led many to sell speculative assets with excessive risk. However, with 2023 offering some positive sentiment, is February the time to consider a growth stock such as Ocado (LSE: OCDO)? Or is this simply a brief bounce before markets decline further?
What does the company do?
Founded in 2000, Ocado operates as an online grocery retailer in the UK and internationally under three segments:
- Ocado Retail;
- UK Solutions & Logistics;
- International Solutions.
What happened in 2022?
As with many companies, Ocado shares declined substantially in 2022. With a fall of 62%, it saw the worst performance of all companies in the FTSE 100. It also saw some of the highest volatility, entering 2022 at 1,500p, only to drop down to 380p in October before new partnerships saw the shares rebound.
How do the fundamentals look?
Growth stocks are often difficult to analyse. Elevated expectations, as well as complex financials, can mean they are often not comparable to traditional companies.
Considering Ocado, a 50% growth estimate is notably higher than the market average of 11%. With no profits expected for the next three years, 12-month share price targets vary by 62%, making investments highly speculative.
Since the company is unprofitable, the price-to-sales (P/S) ratio is used to compare value. It has a ratio of 2.4x, indicating that Ocado is extremely expensive when compared to the industry average of 0.2x. However, with revenue growth of 11.4%, this is also much higher than the average of 3.4%.
With earnings forecasts, an appropriate P/S ratio would be 1.2x, indicating that the share price has potentially gone above fair value.
Historically, growth stocks perform well when interest rates are low. However, with these raised to combat inflation, unprofitable companies need to demonstrate sustainable earnings growth. Unfortunately, Ocado’s losses are increasing at an annual rate of 43% over the last five years.
Despite some negative fundamentals, some metrics of the company look reasonably positive.
The debt of the company is currently sustainable. Both short- and long-term commitments are well covered, and Ocado can operate without income for over two years based on the current cash flow trend.
Like many growth stocks, Ocado does not pay a dividend. This means that all investments are being deployed to develop the company. The management is experienced, and insider trading is overwhelmingly in favour of buying shares. This demonstrates confidence from those with the best understanding of the business.
However, the number of shares outstanding has increased from 750m to 825m in the last year, meaning that the value of each has been diluted by about 10%.
Overall
When looking at the fundamentals of the company, I consider the 2022 decline as justified. As it stands, there is still uncertainty on whether 2023 can see a return to higher prices, or if there is more downside ahead.
The positive trend may continue for growth stocks in 2023. However, for me there is too much risk that another steep decline is on the horizon, amid rising interest rates and low investor sentiment. I will be putting my money elsewhere for now, looking for companies with better fundamentals, and a more certain outlook.
