Whenever I consider adding investments to my portfolio, one of the first things I do is look at each company’s track record of creating wealth for shareholders.
While a business’s past performance never guarantees future success, I believe it provides some indication of how well it’s run. For example, some FTSE 100 companies such as Sainsbury’s (LSE: SBRY) have struggled to retain market share and expand profitability in the past. This can signify that the group has failed to identify with its customers.
In its defence, the company has faced a hostile operating environment over the past decade. The rise of the German discounters, Aldi and Lidl, has disrupted the UK grocery market. This has made it harder for companies like Sainsbury’s to retain customers.
To get around these problems, management has tried to branch out. The group acquired the parent of retailer Argos several years ago. The FTSE 100 business has also slashed prices to compete with competitors.
Unfortunately, none of these efforts seem to have worked. Group operating profit has fallen from £707m for the company’s 2016 financial year, to £679m for fiscal 2020. Sainsbury’s also recently announced it would be cutting 3,500 jobs and closing 420 Argos stores.
Based on Sainsbury’s poor track record of growth, I plan to avoid this FTSE 100 business for the time being. Personally, I feel the company has just made too many mistakes.
But that doesn’t mean the company will never return to growth. Indeed, the group’s latest set of results revealed a 7.1% increase in total retail sales, excluding fuel, for the 28 weeks to 19 September 2020. Free cash flow hit £943m, allowing the organisation to reduce net debt by £912m and pay a special dividend to shareholders of 7.3p.
These numbers are incredibly encouraging, and may be the green shoots of a turnaround. If the group can build on this performance over the next two or three years, the business may be able to reverse the mistakes it’s made in the past.
FTSE 100 growth
A FTSE 100 firm with a better growth track record is distribution group DCC (LSE: DCC). Over the past five years, through a combination of acquisitions and organic growth, this business’s net income has grown at a compound annual rate of just under 9%.
I think this trend is set to continue. Profit margins in the distribution industry are razor-thin. That makes it difficult for smaller companies to compete with larger entities. With revenues of nearly £15bn, DCC has the profit margins and scale other organisations lack. Since 2015, its operating profit margin has grown from 1.7% to around 3%.
That being said, scale doesn’t guarantee success. The FTSE 100 firm has built up a lot of debt in its drive for growth. Net debt was more than double net income at the end of its 2020 financial year. That’s concerning. I’m not too fond of organisations that have to borrow a lot of money and this could cause the company problems further down the road.
Still, for the time being, I think DCC has the scale required to succeed. While the company’s success is by no means guaranteed, I think it’s growth over the past few years shows management’s strategy seems to be working.
The post 1 FTSE 100 stock I’d avoid and 1 I’d buy today appeared first on The Motley Fool UK.
Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2021