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3 reasons why I wouldn’t buy Ocado shares

T Sligo
Bad apple with good apples

Ocado (LSE: OCDO) is often seen as the darling of the FTSE 100. In an index in which most of the components are focused on traditional businesses, it’s refreshing to see a tech company among them.

As much as I would like to support this business and to buy shares, there are several reasons why, at the moment, I wouldn’t.

Profit

My fellow Fool Alan Oscroft notes that analysts suspect that Ocado will not return a profit for the next couple of years.

That being said, the business is making strides under the Ocado Solutions banner and is no longer just seen as an online supermarket.

Just look at the deal it recently struck with long-established Japanese retailer, Aeon. This will see Ocado supply Aeon’s customer fulfilment centres and end-to-end software applications.

In a similar way, I see the business in the same light as Uber: another tech company that has gained momentum but is struggling to turn a profit. Investors in both companies seem to believe that profit is just beyond the horizon. I’m not so sure.

As far as I can tell, Ocado’s share price is currently based on some optimistic expectations.

Years established

Along with profitability, I like to see a company that is well-established. New technology and companies attempting to reinvent the wheel cause me some concern.

The company has been established for almost 20 years. However, it took 15 years to first make a profit.

Even though the business has been trading for some time, Ocado is still very much in the rapid growth phase. Although this might excite some investors, it carries too much risk for me. I’d rather invest in a more established enterprise, with a strong track record of profitability.

Valuation

When writing about the tie-up between Marks & Spencer and Ocado, I mentioned that the price M&S paid was too high.

M&S spent £750m on 50% of Ocado’s UK retail business and will launch a new joint venture. From 2020, Ocado shoppers will see M&S products on the site, rather than Waitrose. Strategically, this could be a good move for both businesses.

M&S shoppers tend to use the store as a top-up for their weekly shops. The average basket at the store totals £20. This could suit the Ocado platform well, with own-brand products being sold alongside M&S premium items.

A lot of M&S shops tend to be in town-centre locations, which again is not suited to a weekly shop. Making the products available for delivery through Ocado could be a good thing.

If the price that M&S paid was too high, at what price tag would I buy shares?

With the likelihood that a profit is not on the horizon for Ocado, I am struggling to put any valuation on the business. However, I understand that with a market share of just 1.4%, Ocado is well-placed for rapid and substantial growth.

If gambling is your thing, Ocado shares might be something you will be interested in. For me, the risk versus reward is too high, leaving the stock one to avoid.

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T Sligo has no position in any of the shares mentioned. The Motley Fool UK has recommended Uber Technologies. 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 2019