Are Marks & Spencer Shares Good Value?

With the Christmas retail results in full swing, now seems like a good time to answer this question.

Marks and Spencer is, of course, a mainstay of many investors’ portfolios, both professional and private alike.  It is, of course, one of the kings of the high street with a long history going back to Michael Marks opening a stall at Leeds Kirkgate Market.  Since then, it has come a very long way, but is it still a good investment given the current difficulties in the retail sector?

In some ways, that’s a trick question because the difficult environment that retainers face is exactly the sort of environment that often creates the best long-term investments.  A happy economy rarely creates compelling buying opportunities.

Choosing a valuation system

Marks and Spencer is, of course, not a ‘cigar butt’ but is instead a market-leading company with a long history of dividend payments, so I’ll be valuing it using the ‘defensive value’ strategy.  This involves looking at long-term earnings growth, the current price relative to those long-term earnings and the current dividend yield and its sustainability.  Together these make up the drivers of long-term equity returns.

So let’s start with the share price chart, as that’s where many investors begin.  That’s generally a huge mistake as the historic share price has little bearing on the long-term future share price, which is instead driven by the future fundamental value of the company.

You can see from the chart that even with a stable, boring old company like Marks and Spencer, the shareholders can still have a very exciting time of it.  However, in effect, by ignoring the massive spike and crash in the share price between 2005 and 2009, it seems that the shares have gone precisely nowhere in 10 years or so.  For many investors, this is enough to put them off as they immediately think that the next ten years are likely to look the same with zero capital gains.

Moving on to the fundamentals of the company, those same ten years or so have produced the following results in revenues, earnings and dividends per share (and it’s per share results that matter).

Are there any signs of growth?

The obvious answer is yes.  At a glance, it looks like revenues are up more than double, as are earnings and almost double for dividends.  Assuming these numbers are broadly sustainable, it means that the intrinsic value of Marks and Spencer may be twice what it was ten years ago, and yet the share price is the same.  If that were true, then the buyer today would be getting twice the value of the buyer from 10 years ago.

The revenue growth rate is around 9%, while the Graham earnings growth rate is around 7%.

The Graham earnings growth rate is calculated like this: take the average of the last three year’s earnings and the average of the three-year earnings period from 10 years ago and calculate the growth rate between those two three-year periods.  This helps to smooth out the volatile nature of earnings.

These growth rates are both comfortably above inflation which is a decent effort for such a mature business.

How much earnings bang are you getting for your hard-earned buck?

The second piece of the investment puzzle is the current price relative to those past earnings.  With a price of 309p when I put these figures together, the PE10 (price relative to 10-year earnings average) was 10.5, which is well below the ceiling of 20 that Ben Graham suggested for large or leading businesses.

What will an investor get paid to hold these shares?

The current dividend yield is around 5.5% which is some 2% or so above that offered by the FTSE 100.  That’s a pretty decent yield and is some way north of the historic average, which is closer to 4%.

Bringing the elements of growth, value and income together

So we now know that earnings growth has been around 7%, the price relative to past earnings is about 10.5, and the current yield is about 5.5%.  That’s all very interesting, but how can that information be used to get a ballpark feel for how attractive M&S may or may not be as an investment?

There are a couple of ways.  One way is to bring those numbers together into a single ratio called PEGY10.  This is simply an extension of the old PEG and PEGY ratios to cover a longer timeframe.  The ratio is simply PE10 divided by the sum of G10 (10-year growth rate) and Y (the current yield).

In Marks and Spencer’s case, this is 10.54 / (6.8 + 5.65), which equals 0.85.  What does that mean?  On its own, it means nothing, but it does allow the shares to be compared to any other shares that have ten years of data available, as well as the FTSE 100 index.  When I compiled this data, the FTSE 100 (at 5,500) had a PE10 of 13.5, a 10-year growth rate of 5% and a dividend yield of 3.6%.  That gives a PEGY10 ratio of 1.56, so clearly, Marks and Spencer is better value by that simple measure.

More clearly, Marks seems to have a higher growth rate, a lower price relative to past earnings (and therefore a higher long-term earnings yield) AND a higher dividend yield, so it beats the index on all the key drivers of long-term equity returns.

Using ranks instead of ratios

Another effective way to compare one stock’s growth, value and income against another is to rank stocks on each factor and then combine those ranks.  This is the approach used by Joel Greenblatt in his Little Book that Beats the Market.

In that book, he ranks the entire universe of stocks by ‘earnings yield’, giving a rank of 1 to the highest, 2 to the next highest and so on.  Then he ranks for ‘return on capital’ and gives a score again starting at 1.  The next step is to simply add those ranks together.  What you get at the end is a list of all the stocks in the universe, and those with the lowest combined rank have the best combination of earnings yield and return on capital.

It’s possible to do the same thing for PE10, Graham growth and dividend yield.  Simply sort the entire universe of stocks by each of those factors in turn and assign a rank to each stock starting at 1.  Then add the ranks together.

Using this ranking system, the FTSE 100 currently has a combined rank of 583, while Marks and Spencer, with its lower PE10, higher growth rate and higher yield, has a combined rank of 387, which puts it in 18th place on my list of FTSE 350 stocks, out of 192 which have enough data for this calculation.

Further analysis

On a purely quantitative basis, Marks and Spencer looks to be exceedingly good value and, therefore, worthy of further analysis.  This doesn’t have to be massively exhaustive but might include, among other things:

  • Looking for a consistent operating history – are they still doing what they’ve done in the past?
  • Checking the debt levels.  Are total borrowings only a few times operating earnings and interest payments covered many times over?
  • Finding out if there are any major problems on the horizon that might impact the company’s long-term earnings power.
  • Thinking about the future of the industry.  Is it doomed, or will it be around for many years yet?

But before getting into a detailed analysis of a company, it’s worth knowing if it has a decent chance of producing good future results, and that’s where a focus on long-term earnings yield, long-term growth and a sustainable income can make a big difference.

Author: John Kingham

I cover both the theory and practice of investing in high-quality UK dividend stocks for long-term income and growth.

15 thoughts on “Are Marks & Spencer Shares Good Value?”

  1. Nice analysis. M&S has long seemed to be a share that gets clobbered by retail scare stories then climbs back. The bigger spike and crash you allude to was to do with corporate action IIRC.

    I’d have a hard time looking past Tesco (which I hold) after this week though. Would be interested to hear how your process stacks up on that one?

    1. Hi Monevator. I think I’m going to mention Tesco next week. When I last built my data it was priced at 400p so there has been a big drop since then down to 315p now. At 400p it wasn’t outstanding value, just okay and probably a ‘hold’, but at 315p? I’m guessing it’ll be far more attractive and perhaps even better than M&S.

  2. Looking at a CROCI analysis M&S cash return on capital invested is around the cost of capital – 5%. Last time it was in a similar position the shares were as low as 198p in Nov 2000. M&S use to reward us with a CROCI of 12% or more.

    Is this a sign of fading, or a result of its target market (afluent people) hit hard by recession ? I am not sure. One thing for sure, M&S has cut its investment (expenditure) in advertising and this can be costly.

    I have decided to stay away from retail apart from holding on my position on Next. It still has a CROCI of 8%, some value left into it. Tesco definetly looks interesting at this price but the management is poor.

    1. Hi Eugen, thanks for commenting. I see what you’re saying about CROCI; I guess different ways of looking at the same shares is always going to produce different results and opinions.

      For me Next is a good company but it seems to be priced in at the moment so there may be less chance of PE or yield reversion. But only time will tell which was the better horse to back I guess.

      I’m with Buffett on Tesco though. At the right price it makes a lot of sense (and we’re probably around the right price now) and I think management will have to work pretty hard to mess it all up, but anything’s possible!

      1. There is not much value left in Next, you are right. For me is a hold as I have already own it for nearly 2 years.

        Tesco price is fair now but probably it will go lower first. We need to think we are not W. Buffett, our timescale but expecialy our resourses are not the same. He can afford to wait 5 years or even more for Tesco to comeback and in the meantime he will increase his position. If the price wars are going to continue we will see more ‘profit warnings’.

        For me retails is a ‘not go’ area at the moment.

        These are only my oppinions. Good luck investing.

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