Questor: Don’t listen to the contrarians, there’s plenty of road left for this marketplace

Share tip: this company’s competitive advantage is set to rev up its performance

Investors are usually either trend followers or contrarians. The former seek to buy stocks that have risen rapidly in the hope of benefitting from a continued upward surge. The latter, by contrast, aim to purchase shares that have fallen heavily and now trade significantly below intrinsic value.
While Questor typically adopts a contrarian stance, this does not preclude it from backing stocks that have risen significantly in value. Indeed this column believes that most contrarians are far too rigid in their approach. By refusing to even contemplate popular stocks that have risen sharply in value, they regularly miss out on potential long-term winners.
Auto Trader Group is loved by trend followers at present. The online automotive marketplace’s shares have risen by 15pc this year and by 26pc over the past 12 months. Since this column first tipped them in September 2018, they have generated a 75pc capital gain. This compares favourably with the FTSE 100 index’s 10pc capital return over the same period.
While most contrarians would now argue the stock is vastly overpriced after its recent gains have pushed its price-to-earnings (P/E) ratio to 27.6, Questor takes a very different view. The firm’s excellent market position means it is poised to deliver strong profit growth as the UK economy experiences a purple patch.
Already the company is growing at a faster pace than many investors realise. Sales and operating profits were up 14pc and 26pc respectively in the 12 months to March this year in spite of a tough operating environment. 
Now that inflation is in line with the Bank of England’s 2pc target, the economy has returned to positive growth and interest rate cuts are on the near-term horizon. The prospects for the company are increasingly upbeat.
Meanwhile, Auto Trader’s return on equity of 48pc in its most recent financial year evidences its excellent market position. The firm is roughly 10 times larger than its nearest competitor, with over 75pc of all minutes spent on automotive classified sites occurring on Auto Trader. This clear competitive advantage means it is well placed to capitalise on an improving industry outlook as disposable incomes swell in real terms and equate to greater purchasing power.
A clear competitive advantage also brings pricing power. Questor has been at pains to point out the value of pricing power during the recent period of rampant inflation. It provided scope to maintain or even expand profit margins despite rapidly rising costs. Now pricing power allows Auto Trader to maximise its returns as the performance of the automotive retailers that rely on its website gradually improves. 
Indeed the company’s average revenue per retailer rose by 12pc in the latest financial year even as high interest rates restricted demand for new vehicles. This contributed to a six percentage point increase in operating profit margin versus the prior year – with it now standing at 61pc.
As ever, the company’s financial position remains sound. Net gearing of under 3pc and net interest cover of almost 100 are likely to be among the strongest figures found in the FTSE 100 index. They provide further evidence of the scale of the firm’s competitive advantage, with return on equity not being boosted by excessively high borrowing. 
A solid financial position also provides scope for surplus capital to be used for ongoing share buybacks as the company returned £170m to shareholders in its latest financial year alone.
The firm’s continued innovation and release of new products provide scope for additional growth. Its move into part-exchange valuations, finance applications and vehicle leasing could prove to be long-term catalysts to its financial performance as they add value for consumers through simplifying the process of buying a car. 
Of course, many contrarian investors will remain unconvinced by Auto Trader’s relatively rich P/E ratio and recent share price surge. However, the company’s strong market position, sound finances and bright operating outlook mean it continues to merit a premium valuation vis-à-vis the wider FTSE 100 index.
Clearly, no trend lasts forever.
But in Questor’s view, the stock continues to offer capital growth potential and index outperformance even after its stunning returns.
Questor says: buy
Ticker: AUTO
Share price: 811.2p
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