No one knows when inflation will fall to 2pc. When it happens, this stock is ready to capitalise
The online vehicle marketplace’s dominant position makes it well positioned to take advantage when the economic situation improves
Inflation is proving to be a difficult beast for the Bank of England to tame. While it has almost halved over the past six months, annual inflation still stands at twice the Bank’s 2pc target. And after a rise of 0.1 of a percentage point in December, against expectations of a fall of the same magnitude, investors are becoming increasingly concerned it could prove to be stickier than first envisaged. A stubbornly high rate of inflation means interest rate cuts are likely to be delayed. In turn, the near-term prospects for the economy, and stock market, are likely to be rather more challenging than many investors had expected.
In Questor’s view, inflation will ultimately return to the Bank’s 2pc target and interest rates will fall considerably from their current level. Therefore, the long-term prospects for the economy and stock market are far more ebullient than today’s downbeat investor sentiment suggests.
Of course, trying to predict the timing of these events is likely to prove futile in view of their wholly unforecastable nature. Therefore, the best course of action for investors is to continue to hold high-quality companies that can overcome shortterm difficulties and prosper as more sanguine conditions emerge over the long run. Auto Trader, for example, is well placed to benefit from an evolving economic outlook. The online vehicle marketplace’s latest half-year results showed it had retained its dominant market position: more than 75pc of all the time spent on automotive classified websites in Britain was on its site. And with debts of just 6pc of assets and interest bills covered 91 times by profits during the six-month period, it is financially sound.
Clearly, demand for new and used vehicles will always be lower when above-target inflation is squeezing disposable incomes and high interest rates are making car finance deals less affordable. When a stagnant economy is added to the mix, it is encouraging that the company produced revenue growth of 12pc and a rise in operating profits of 10pc in the first half of the year. This performance shows the company’s strong competitive position. Moreover, new products such as part-exchange car valuations and online applications for finance, as well as a continued shift into car leasing, are likely to further strengthen Auto Trader’s competitive advantage.
Since their addition to our Wealth Preserver portfolio in July 2021, the company’s shares have risen by around 15pc. While this is only a modest increase, it is nevertheless nine percentage points better than the FTSE 100 has managed.
The stock’s return, though, has failed to keep up with inflation.
‘Long-term prospects for the economy and stock market are far more ebullient than today’s investor sentiment’
Moreover, a share price multiple of 26 times forecast earnings is very high on a relative basis.
The company, though, is in a strong position to capitalise on an eventual fall in inflation, interest rate cuts and an improving economic performance. Its ability to deliver an impressive financial performance amid extremely tough operating conditions highlights a very strong competitive advantage that will allow it ultimately to deliver significant capital returns that easily trump inflation. Hold.
Update: RWS
Translation specialist RWS is also experiencing a tough operating environment as a result of challenging economic conditions.
Its recently released full-year results reported a fall in revenue of 2pc thanks to lower levels of client activity, while pre-tax profits fell by 12pc relative to the previous year. Despite its disappointing financial performance, the company reported high levels of customer retention across all divisions. It also delivered £25m in annualised cost savings, which should support profit margins in the current financial year.
The company’s modest net debt of £10m highlights its financial strength, which has enabled it to make acquisitions over recent months. Further takeovers could boost its competitive position, while investment in areas such as artificial intelligence could pay off over the long run.
Shares in RWS have fallen by 58pc since we added them to our Wealth Preserver portfolio in June 2021. Ultimately, the company requires an improvement in operating conditions to deliver a stronger financial performance that gets its share price moving. A modest share price multiple of around 10 times forecast earnings and the prospect of economic conditions more conducive to growth make it well placed to recover. Hold.