Burberry Shares: Are they too fashionable for their own good?

Burberry Group PLC (BRBY) has had a pretty fantastic run of success over the past decade, and so have its shares, with gains of more than 600% since the credit crunch. 

That’s one of the most impressive rebounds I’ve seen since the dark days of 2009, but does that mean that the best gains for Burberry shares are behind us?  Let’s try to find out.

First though, just to remind you, here are the four things that I’m looking for from an investment:

1. High yield – Higher than the FTSE 100 or All-Share (i.e. the market)
2. High growth – Faster dividend and share price growth than the market
3. Low risk – Share prices that are less volatile than the market
4. Low stress – Companies that produce more good news than bad and those that can be more or less ignored for months on end without having to worry.

I’ll start off where I usually start, which is with the company’s financial history.

Good results that just keep getting better

Can you see the financial crisis in the chart below?  Other than the merest blip to earnings in the 2008 results and flat revenue growth in 2010, it’s barely noticeable.  The rest of the time it’s been wave after wave of success for Burberry.

Here’s a quick run-down of the key numbers:

• Growth rate – Burberry managed to average a very impressive 17.1% a year, while the FTSE 100 has only managed to grow revenues, profits and dividends at 2.3% a year over the same time period.
• Growth quality – I like to measure the consistency with which revenues, profits and dividends have been made and grown.  Burberry scores a very respectable 93%, while the pedestrian FTSE 100 scraps by with just 79% consistency.
• Debt ratio – My approach here is to compare the company’s total borrowings to a quantitative estimate of its average net profit through the next business cycle.  Burberry looks good once again, with borrowings around £130 million compared to estimated average future net profits of £335 million, giving a debt ratio of just 0.4.  In most cases, I consider a ratio of less than five as prudent.

Clearly, Burberry has blown the large-cap competition away over the past decade.  It’s growing fast, it’s growing consistently, and it hasn’t had to use huge amounts of debt to achieve that.

So how has it managed it?

A super-brand for a fast-emerging middle-class

As far as I can see, the root cause behind Burberry’s success is quite simple.

1. They’re a desirable brand in a desirable segment (British luxury)
2. The number of people on Earth who are aware of Burberry, want to buy Burberry and have enough disposable income to buy Burberry products is growing massively due to the rapid growth of emerging markets.

Growth fuelled by a growing market is probably the best sort of growth a company can have.  Competition is often less fierce because the competing companies are doing all they can just to keep up with growing demand.  Basically, everybody’s happy because they’re growing, so they don’t worry too much about stealing additional market share from their competitors.

I think this story of emerging market growth has many years to run, so my basic assumption is that Burberry could grow a lot bigger than it is today.

What price fashion?

Burberry is clearly a very good company, and I would be more than happy to buy a few of its shares, but what price is a good price?

Today, the share price is 1,546p.  At that price, the dividend yield is about 1.9% compared to a historic dividend yield of 3.4% for the FTSE 100, so it’s not going to give me the high yield that I’m after; but that’s hardly surprising.

After all, you shouldn’t really expect to get a dividend yield that matches that of the market when you’re buying a company that is growing 15% a year faster than the market.

Burberry also has a very high PE10 (price to 10-year average earnings), and that’s understandable, as quality companies usually attract a premium price.  In this case, Burberry’s PE10 is 38 while the FTSE 100’s is just over 14.

As you can see, there is always a trade-off between income, growth, quality and value.

Let’s have a look at Burberry’s shares against its performance peers.

If I use the UKVI stock screen to hone in on companies with a 15-20% growth rate and 90% growth quality or higher, I get a list of 13 companies, of which Burberry is one.

The group’s median growth rate is 17.3%, almost exactly the same as Burberry’s, and the median growth quality is 95%, slightly better than Burberry’s.

The median dividend yield is 2.1%, so Burberry has a slightly lower yield than this group of similarly successful companies.

The median PE10 of the group is 32, so Burberry’s share price is slightly higher than average relative to past earnings.

Both of those factors – a lower yield and a higher price relative to earnings – are indicators that perhaps Burberry is slightly expensive.  Not just relative to the market, which you would expect as it is a much higher quality company than the average company, but also relative to 13 other companies that have been just as successful in the last decade.

Not quite ‘fair value’ for Burberry

If the average of those 13 companies represents ‘fair value’ for companies growing that quickly and that consistently, then Burberry should have a dividend yield of about 2.1% and a PE10 ratio of about 32.

To achieve that valuation, the shares would have to be priced at 1,300p, not the 1,546p that they currently sit at.

However, that is just the ‘fair value’ price.  To be ‘good value’, I would want to see the share price drop some way below 1,300p.  That would increase the odds of the investment producing above-average returns, and it would also provide some margin of safety in case Burberry’s future turned out to be not quite as bright as its past.

Disclosure:  I don’t own any shares in Burberry.