Next's shares are up 100% since 2022: Time to buy or sell?

Next (one of the UK's leading clothing and homewares retailers) is an exceptional business by almost any standard, especially as it doesn’t seem to have any structural competitive advantages like market dominance or network effects.

Despite this lack of structural advantages, Next has grown its earnings per share from 93p to 656p over the last 20 years, and its dividend from 35p to 207p. Next's share price has responded to that growth by increasing more than seven-fold from £13 in 2004 to over £100 today.

Those results are impressive. They’re all the more impressive because they were achieved during a period of significant disruption for bricks-and-mortar retailers and because they were achieved without the risk of large acquisitions of the rocket fuel of excessive debt.

Following the pandemic, Next has continued to be successful and that has attracted much attention. In fact, Next's share price has more than doubled since the late 2022 Liz Truss debacle and it's now sitting comfortably at an all-time high.

Momentum investors will no doubt be buying the company's shares at this precise moment, and good luck to them. But as a dyed-in-the-wool value investor, I've decided to sell my shares to lock in the gains I've accrued since I first added Next to my portfolio in 2016.

Having sold Next earlier this week, I thought it would be useful to review why I bought the shares in the first place, what happened while I held them and why I've finally decided to sell up and move on.

And as I'm still a fan of the company, I'll also cover the share price I'd be happy to reinvest at.

Table of contents

• Why did I invest in Next in 2016?
• How did Next perform while it was in the portfolio?
• Why have I decided to sell Next now?
• How much would I pay to reinvest in Next?

You can also download this review as a PDF:

• Next 2024 09 Sale Review (PDF)

Why did I invest in Next in 2016?

I’ve already said that Next is an exceptional business and that was just as true when I added it to the portfolio in 2016.

A long track record of financial success

Over the ten years leading up to 2016, Next had grown very consistently at a rate of about 12% per year. That’s no mean feat, especially as the period included the global financial crisis, which Next somehow managed to sail through with barely a scratch and an easily maintained dividend.

Chart taken from my original 2016 Purchase Review of Next (PDF)

That growth was powered by the company’s impressive profitability, with net returns on capital that had averaged a mind-boggling 45% over the previous ten years. That figure excludes leased capital (ie rented stores, which I didn't pay attention to in 2016), but it’s still impressive.

Next’s habit of paying a prudent ordinary dividend also allowed it to buy back almost 40% of its shares over those ten years. That dramatically increased its per-share growth rate above the somewhat pedestrian growth of the overall business, highlighting the fact that Next is an outstanding allocator of shareholder capital.

The balance sheet was also comfortingly robust in 2016, with little in the way of debt and (although I didn’t pay attention to them at the time) short leases on its stores. That combination was ideal for a business operating in an industry being disrupted by the transition to online shopping.

If I had to summarise all of that in one sentence, I'd say that Next’s financial track record was virtually peerless among large UK retailers.

An exceptional business with deep expertise in its niche

Although Next was a relatively young brand in 2016, with the name going back a mere 34 years to 1982, the business hadn’t started out as a single store (like Ted Baker) or even as a market stall (like Dunelm). Instead, Next was born from the amalgamation of Hepworth and Kendall & Sons, two long-established clothing manufacturers and retailers founded in the 19th century.

The fact that Next’s origins dated back over 100 years is important because it told me that the business had already developed the knowledge, culture and relationships (with customers and suppliers) to survive and thrive through good times and bad and through many social and technological changes. That’s good because it meant that Next was well-placed to survive and thrive over the decades ahead and, as a long-term investor, that’s exactly what I’m after.

Looking at Next’s business in a bit more detail, it started as Hepworth (a chain of menswear stores, known for its ready-to-wear suits) and Kendall & Sons (a high-end ladies outerwear retailer, known for its umbrellas), and both were to some extent vertically integrated (they mostly designed, manufactured and sold clothing under their own brands, rather than selling third-party brands).

Those businesses were merged and rebranded as Next in the early 1980s and since then, Next hasn’t strayed far from those strong foundations. It’s still primarily a menswear and ladieswear retailer selling own-brand clothing that is largely designed or co-designed in-house, although manufacturing has long since been outsourced to manufacturers in lower-cost countries.

Shortly after it was born, Next acquired Grattan (the catalogue company) and used it to develop a mail-order catalogue business called Next Directory. Childrenswear and homewares were also added in the 1980s and these four categories are still the company’s bread and butter today.

And so, in 2016, Next appeared to be a fairly run-of-the-mill chain of mostly UK department stores, selling clothing and homewares and looking a lot like M&S and Debenhams. But while those two companies were struggling (and Debenhams eventually went bust), Next was going from strength to strength, which begs the question: Why?

A powerful but potentially fragile competitive advantage

Companies only survive and thrive over decades if they have durable competitive advantages. 

In Next’s case, although it was one of the UK’s largest clothing retailers in 2016, it wasn’t large enough to dominate its competitors with unbeatable economies of scale. And, while it had a strong brand that was well-known and well-regarded, Topshop, Debenhams and Ted Baker also had strong brands at some point, but that wasn’t enough to stop them from going bust.

So what made Next successful in the early 21st century, while many of its bricks-and-mortar peers fell into decline?

The answer, I’m reluctant to say, is Simon Wolfson, Next’s long-serving CEO.

Wolfson’s father was chairman of Next from 1990 until 1998. During that time, the younger Wolfson joined Next as a sales assistant and by 2001 he was CEO, making him the FTSE 100’s youngest CEO. In 2016, Wolfson was still CEO and, amazingly, he’s still CEO today, making him the longest-serving CEO in the FTSE 100.

This differentiated Next in two ways: 

First, having worked in the business since 1991 and having been CEO since 2001, Wolfson had a deep understanding of Next and the wider retail industry (just watch one of his long and detailed annual results presentations). Amazingly enough, this isn’t always the case and you’ll often find CEOs joining companies (or even industries) they’ve never previously worked in.

Second, Wolfson has always tried to run Next in a way that produces sustainable long-term earnings per share growth, which means growth that is sustainable over the next ten or twenty years, not the next three or five years.

Amazingly enough, this isn’t the case at many companies. Instead, many public company CEOs run those businesses with the goal of maximising profit three or five years from now, because (a) that’s the time horizon most institutional investors care about and (b) that’s when most CEOs will move on to the next stepping stone in their career.

Unfortunately, that kind of short-term thinking often leads to unnecessary “transformations” or a lack of investment in the business, both of which can have negative long-term consequences.

For example, in 2017, Burberry hired an outsider CEO (replacing Christopher Bailey, who’d worked at Burberry since 2001). That CEO came up with a grand plan to transform Burberry from a premium brand into a luxury brand, selling clothing at a significantly higher price point. That sounds great, but brands only have so much elasticity. If you move them to a higher place in the market too quickly, customers won’t follow, and this is the main reason why Burberry has run into serious problems in 2024.

Alternatively, Hargreaves Lansdown has had nothing but outsider CEOs since the founders left the business in 2010. These outsider CEOs led a business in which they had almost no experience, and it now seems they boosted short-term profits by underinvesting in the kind of technology platform that would be essential for HL’s long-term success.

(Disclosure: At this point, I should mention that Burberry and Hargreaves Lansdown are both holdings in my real-world portfolio and the UK Dividend Stocks Portfolio)

Turning back to Next, although it doesn’t seem like much, having a long-term thinker with extensive experience in the business and its industry at the helm since 2001 has differentiated Next from its peers and it is a competitive advantage. But, it isn’t durable. 

Wolfson will leave Next at some point and then where will its competitive edge be?

Ideally, Wolfson will have made sure that Next can develop outstanding leaders internally, so it can effectively build the next Wolfson rather than having to buy one from outside the business. This is what many great businesses have done, but we won’t know if this is the case with Next until Wolfson has gone, so until then, this remains a fragile competitive advantage.

An attractive valuation

Last but not least, Next had an attractive share price in late 2016. At £49.64, the share price was down about 40% from its 2015 peak, as investors worried about the impact of Brexit and Wolfson’s transparent admission that 2017 could be the most difficult year since 2008 (outstanding CEOs are painfully honest with their shareholders).

That lower share price pushed Next's dividend yield up to 3.2% and the PE10 ratio (the ratio of price to ten-year average earnings) down to 17.6, both of which were green lights as far as I was concerned.

My assumption at the time was that Brexit was unlikely to have a materially negative impact on the business and that Next would continue to grow over the long term. On that basis, I was happy to add it to my portfolio.

How did Next perform while it was in the portfolio?

Having invested in Next, the retail environment and the company’s results over the next few years were worse than I’d expected. Revenues and earnings were essentially flat for the next four years and the dividend was held flat for two years, but underneath those lacklustre results, there was solid operational progress.

That progress was mostly evident through Next’s ongoing investment in its transition to an online-first business. Luckily, Next already had a mail-order catalogue business when the Web appeared in the 1990s, so it already had the infrastructure to handle home orders, deliveries and returns. That made it relatively easy to set up a transactional website in the late 1990s, although, at first, it was little more than an electronic catalogue.

However, by the time I invested in 2016, almost 40% of Next’s revenues were generated online and by the time the pandemic arrived in 2020, that had increased to 50%.

Evolving into an all-in-one e-commerce platform

Critically, Next’s strategy to thrive in an online-first world became increasingly differentiated from its peers in several important ways.

Retaining stores: First, rather than attempting to become a pure-play online retailer by rapidly closing most of its stores, it chose to keep a significant number of large out-of-town stores open to use them as convenient and customer-friendly pick-up/drop-off points for online orders. 

Bespoke systems: Second, it spent a considerable amount of time and money developing its own bespoke e-commerce, warehousing and logistics systems, giving it far more control over how it takes and fulfils online orders than it would have with off-the-shelf solutions.

Third-party brands: Third, it started selling third-party branded clothing through its website, giving customers more choice and turning its website into a one-stop shop for a range of complementary fashion brands. Third-party brands now generate more than £1 billion in annual sales or almost 20% of Next's total sales.

Componentising the business: Fourth, as third-party brand sales grew, Next separated its operations into two parts: buying and selling. The buying part would focus on everything related to designing and manufacturing Next's own-brand products. The selling part would run the website, warehouses, stores and other selling and distribution infrastructure, and it would treat the buying side of Next as just another clothing brand looking for an online/offline distribution channel.

Becoming a platform business: Fifth, Next realised that its well-invested and highly flexible website and logistics operations could do more than sell and distribute Next and third-party products through Next's website. Instead, they could underpin all of the online operations for smaller competitors, including websites, order-taking, credit facilities, delivery, customer support and returns (including to Next stores). Today, this Total Platform offer has several clients, including Laura Ashley and GAP.

Becoming a serial acquirer: Sixth, having ironed out Total Platform’s teething problems and made the onboarding process significantly more efficient, Next realised it could do something similar with back-office departments such as accounting and HR. That would enable it to acquire smaller peers and then unlock powerful synergistic benefits by moving their online operations onto Total Platform and by replacing their back-office operations with the more efficient operations of Next.

This Total Enterprise Platform has a lot of potential because it enables Next to profit by scaling up businesses that sell into parts of the market the Next brand cannot reach (remember the Burberry example: Brands can only stretch so far). It's also useful because the Next brand is probably approaching saturation in the UK, so acquiring other popular brands could be a way to continue growing the business beyond what’s possible with one brand.

So far, Next has acquired all or part of Joules, Reiss, FatFace and MADE.

This enterprise platform business is still only a tiny part of Next’s overall business, but it does show what can be done when management has deep expertise and a long-term owner-like mindset. More broadly, Next has shown itself to be a great business by preserving and strengthening its core retail business while simultaneously evolving the business to position it for sustainable long-term growth.

Put simply, Next is quite possibly the best retailer in the UK, and long may its success continue.

A robust performance during and after the pandemic

More recently, Next’s performance during the pandemic was notable for two reasons. First, although the company’s websites and stores were closed for a time in 2020, it still managed to produce a profit that year and every year through the pandemic. And while some dividends were delayed, the dividend wasn’t suspended.

Even more impressively, as the pandemic faded into the background, Next rebounded faster and further than I (and probably most investors) expected.

Data source: SharePad

That outstanding post-pandemic performance means that on a per-share basis, Next’s revenues, earnings and dividends have increased by 60%, 50% and 31% since I invested in 2016. That's pretty good for a UK retailer during a less-than-ideal economic period.

Solid share price gains, especially over the last two years

Those strong post-pandemic results have given investors a reason to be enthusiastic about Next and the share price has responded accordingly.

Chart via ShareScope

The chart above shows that the current price of just over £100 is more than double my original purchase price, and it's double the late-2022 lows caused by the short-lived Liz Truss episode.

The chart also shows some in-holding trades (the small red and green squares) where I trimmed or topped up the position to keep it reasonably close to my target position size. 

Admittedly, there was too much trading in early 2021 as I experimented with an active position sizing system (which I subsequently dropped in favour of a simple equal-weight approach), but the effective result was that I opened the position at £50, took some profits at £75, topped it up at £64, trimmed it for a second time at £85 and now I’m selling at just over £100.

Why have I decided to sell Next now?

The simple answer is that Next’s rising share price is now very close to my estimate of the company’s fair value.

There are various ways to calculate fair value, and my approach is to estimate the company's future earnings and dividends for the next few years and then assume I sell the shares at a historically average PE ratio. I then discount those various returns to take account of the time value of money, and that gives me a present value (or fair value) for that future stream of cash flows. 

This is called a discounted dividend model and here are the assumptions I used to build my model and estimate Next’s fair value:

1. The company's net return on capital stays at a historically average 21%
2. Dividend cover (including special dividends and buybacks) remains at 1.3, which is historically average when Next’s semi-regular special dividends and buybacks are included
3. This retains enough earnings to fund a 5% medium-term growth rate
4. In 2034, the shares are sold at a historically normal PE of 15, giving a sale price of £133.16.

Under those assumptions, Next’s fair value would be £104.21, which is only fractionally higher than the current share price. This means if I were to continue holding Next's shares until 2034, I would only expect to get a market-average return and, as an active investor, I’m looking for a market-beating return.

Just as importantly, Next’s higher share price means that the ordinary dividend yield has fallen to just 2% and, as a dividend investor, I want an ordinary yield of at least 3%. And while Next does return additional cash through special dividends and buybacks, which boosts the potential shareholder yield to more than 3%, special dividends and buybacks can’t be relied upon for regular income.

For those reasons, I have decided to sell Next and reinvest the proceeds into Burberry. I sold Next earlier this week at £101.20 and used some of the proceeds to top up Burberry as its share price has fallen almost 75% since its all-time high just over a year ago.

Overall, I would say the investment in Next worked out very well and it's a good example of how I'd like every investment to turn out. In other words, I invested in a great business after the share price had fallen due to concerns over its short-term future. The company eventually performed better than expected and the share price re-rated, producing a near-15% annualised return over seven years.

Sadly, not all investments work out this well, but this is the gold standard I'm aiming for.

How much would I pay to reinvest in Next?

Because I still like Next, I would be happy to reinvest at the right price.

As a general rule, I only invest in companies if their price is more than 33% below my fair value estimate (known as the discount to fair value). In Next's case, my fair value estimate is £104.21, so that gives me a target purchase price of £68.

That may seem unrealistically low, but the shares were at that level just over a year ago, so there's no fundamental reason why they couldn't fall back to that level if Next disappointed the market with an unexpected profit warning or two. I don't think that will happen, but you never know.