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Ocado share price: 19.3bn reasons why I’m cautious

Jonathan Smith
·3-min read
Note paper with question mark on orange background
Note paper with question mark on orange background

The Motley Fool’s readers are quick thinkers so you’ll likely have figured out that the figure in my title relates to £19.3bn. That’s the approximate current market capitalisation of Ocado (LSE:OCDO). But why is this a reason for concern? After all, I’ve been bullish on the stock since the beginning of the year.

During the first lockdown back in Q2, I wrote about how I thought the Ocado share price could perform very well in the pandemic. The firm has a large distribution network and an established online presence. This e-supermarket was suited perfectly to consumers who couldn’t (or didn’t want to) leave home for food shopping. That was seen in the half-year results, with retail revenue up 27%. This growth was on top of existing growth from the previous period.

Is the Ocado share price fairly priced?

The snowballing impact of an increase in demand from the lockdown saw the Ocado share price surge. At a time when most FTSE 100 stocks were falling, the price rose quickly. At a current price of just under 2,600p, it has virtually doubled this year. The market cap figure has risen in line with this, as it’s calculated by multiplying the share price by the number of shares in the market. Investors often use the market cap figure as a measure of the overall value of the business.

This brings me to the reason I’m starting to think the Ocado share price is looking overvalued after the incredible surge this year. As mentioned, the market cap stands at £19.3bn. By comparison, the Tesco market cap is £21.3bn. J Sainsbury is £4.47bn, with WM Morrison at £3.95bn.

Now take a look at the market share of UK grocers from Statista up to May 2020. It has Tesco firmly in front, with 27% of the total market share. Sainsbury’s and Morrisons have 15% and 10% respectively. What about Ocado? It has a share of just 1.6%. Hopefully you can now see the reason I’m concerned. Should an online supermarket that holds just 1.6% of the market really have a value close to the firm that has 27%?

It’s a growth stock

Some of you in your head right now are thinking “but it’s a growth stock“. It’s true, Ocado is seen as a high-growth stock, with a large technology focus. From this, you can look past current market share levels and price the stock as a multiple of future potential earnings or size. This has become a much more accepted investment strategy in recent years (just take a look at Tesla).

Despite this, I think Ocado at its core is still just an online supermarket. Therefore I struggle to justify the argument that the Ocado share price should be allowed to trade at such a high level for a continued period of time. In my opinion, the share price was a great buy throughout most of the year, but right now I’d stay away and wait for a correction lower.

The post Ocado share price: 19.3bn reasons why I’m cautious appeared first on The Motley Fool UK.

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jonathansmith1 has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Tesla. 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 2020