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Questor: WPP shares have fallen by 18pc since our tip. This is why you should hold on
This week we return to one of the stocks tipped over the past year to see if it still deserves the “buy” rating we gave it. The stock is WPP, the advertising giant run by Sir Martin Sorrell.
We advised readers to buy the shares in mid-March at a price of £17.07 but they have hardly covered themselves in glory, with a fall of about 18pc since then.
In these circumstances the instinctive reaction is often to sell in fear that the losses can only worsen. The correct response for a disciplined investor, however, is to look dispassionately at the investment case to determine whether anything has changed since the stock was bought.
If something has, a new assessment of the company’s fundamentals and valuation is required. If not, trust your original analysis and hold on to the shares.
We asked the fund firm on whose judgment we based our original WPP tip whether its view of the company had changed. Its response was reassuring: it has not sold its own holding – indeed, it has bought more shares in the company as a result of the price weakness. For Questor, this last point especially is a sure sign that readers should hold on to their own WPP shares.
“The market has gone cool on WPP, and others in the sector, because revenues have become broadly flat,” said Stephen Walker of Sanlam FOUR, the asset manager concerned. “To change investors’ perception of these stocks will require growth in revenues – the shares won’t perform if there is zero revenue growth next year.
“We would say that WPP’s sales will indeed be broadly flat this year and might remain soggy for a period, so investors should not expect instant gratification. But the sector is priced for annual revenue growth of only about 0.5pc in perpetuity.”
These pessimistic expectations have several causes, Walker said. First, there are fears that the large consumer goods companies such as Unilever will cut their advertising spending permanently.
The Anglo-Dutch giant fought off a takeover bid earlier this year partly by pledging to boost margins by careful cost control, and there is a growing vogue for so-called “zero-based budgeting”.
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“This trend has made waves across the whole industry and many consumer goods firms are squeezing marketing budgets,” Walker told Questor. “These businesses account for about 30pc of advertisers’ revenues. Unilever, for example, is squeezing its spending on advertising by about 20pc.
“But we would contend that, having squeezed your advertising budget heavily, you revert to increases. The likes of Unilever have to innovate to maintain customers’ interest in their products – and when you innovate you have to tell people about it. The marketing industry is not going to go away.”
Another perceived danger is the rise of smaller brands in niche areas that bypass the big advertising groups by marketing their products digitally. But Walker said these firms “tend to get taken over by the big guys, who then use their old marketing machines – if you are a bigger company you want a holistic approach to marketing, which offers advantages such as global reach and measurability”.
He said Sir Martin’s own prediction was that WPP should grow its sales by a couple of per cent next year.
“WPP is a very good business that has generated a lot of value over time but gets hammered for a flat year,” Walker said. “It also pays a nice dividend, with a 4.4pc prospective yield. I can’t see a threat to that dividend as it is at least twice covered by profits.
“The shares have come down a long way and now look very cheap, with a valuation of about 11.4 times earnings for 2017.”
He concluded: “We have topped up our holding in WPP so that its weighting in the fund is back to where it was before the share price fall. We have also added Publicis, the French group, to the portfolio – its shares have fallen similarly. Advertising is one of our biggest exposures and I think the sector is a steal.
“We are definitely sticking with WPP. You need a 12 to 18-month time horizon as an investor, but we are being paid to wait, thanks to the dividend.”
Questor says: hold
Ticker: WPP
Share price at close: £14.01
- See all our Questor tips: telegraph.co.uk/questor