The stock market has a stunning long-term record. The FTSE 250 index, for example, has generated an 8pc annualised capital gain over the past two decades. Long-term investors who buy and hold a diverse range of shares are very likely to obtain attractive returns. In fact, the stock market’s performance is relatively predictable over the long run.
Its short-term performance is the polar opposite. While many investors spend countless hours trying to work out how share prices will change over days, weeks and months, they are seeking to forecast what is essentially a random event.
Similarly, the short-term financial performance of listed companies is also a “known unknown”. An obvious recent example is the FTSE 100 retailer Next, which reported a far better Christmas trading performance than it, and the stock market, expected.
In spite of a seemingly endless supply of negative news regarding the cost of living crisis and its apparently guaranteed detrimental impact on retailers, the company achieved a 4.8pc increase in full-price sales in the nine weeks to Dec 30.
This was vastly better than the minus 2pc forecast offered previously by the business and was largely down to a change in the weather. After a warmer than expected October and November, a cold snap in December prompted a surge in demand for winter clothing that boosted the company’s top line.
It also underestimated the impact that much improved stock levels would have on year-on-year sales figures after major supply chain problems experienced in the previous year.
Following its better than expected performance, Next upgraded its pre-tax profit guidance for the year to January 2023 by £20m to £860m. However, it remains cautious on its 2024 prospects. It is currently forecasting a 1.5pc drop in sales and a 7.6pc fall in pre-tax profits for the year to January 2024 thanks to factors such as rising mortgage costs, high inflation and a weakening economic outlook.
The Bank of England currently expects Britain to experience its longest recession since records began. It forecasts that negative growth will persist until 2024. Consumers are just as downbeat about the future. Consumer confidence, while slightly higher than the record low recorded in September, remains at an exceptionally low ebb that suggests retailers such as Next face an Armageddon-like near-term future.
Whether it materialises or not we cannot predict. Just as a case can be made for worsening operating conditions for retailers, so too can one be made for a more sanguine outlook. For example, energy prices have already slumped, interest rate rises are expected to reduce inflation materially over the coming months and, with unemployment levels still close to record lows, the prospects for consumers could yet improve.
Either way, Next offers an excellent long-term outlook for investors. The company has the financial strength not only to cope with tough trading conditions but to take advantage of them by acquiring less stable peers. For instance, it recently bought Joules out of administration in a deal that will see the latter retain creative independence while benefiting from Next’s vast logistical network.
The company’s “omnichannel” focus makes it well placed to evolve in tandem with changing consumer digital preferences, which have moderated as Covid restrictions have eased. And with a broad range of operations, alongside international exposure, it offers greater diversity, and therefore less risk, than many of its FTSE 350 retail rivals.
Since this column advised readers to buy Next in November 2020, its shares have gained around 13pc. They currently trade on a price-to-earnings ratio of 12.6, which in Questor’s view significantly undervalues the business on a long-term view.
Its profitability could materially worsen or dramatically improve over the coming months and investors have no way to predict the outcome over such a short time period. Of far more importance to long-term investors are its solid finances and sound market position, as well as its wide margin of safety, which mean further capital growth is highly likely over the coming years.
Questor says: buy
Ticker: NXT
Share price at close: £65.84
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