I’ve started looking at shares I feel could outperform in 2022. I think Auto Trader (LSE: AUTO), a FTSE 100 company, is a potential buy for my portfolio.
Auto Trader is the leading digital market place in the UK for vehicles. The company was founded back in 1970 and was originally known for its printed magazine. But after launching its website in 1996, and discontinuing print magazines in 2013, the company is now a digital-only business.
I’ll review the bull and bear case for Auto Trader, before deciding if I should buy the shares.
A FTSE 100 stock with an economic moat
As FTSE 100 companies go, I think Auto Trader is a great one due to its economic moat.
An economic moat is a way of saying a company will generally not lose market share as it has a uniquely powerful position. It could even grow its share over time by being the dominant competitor. I think Auto Trader shows all the signs of having an economic moat. For example, the company says people spend seven times more on its website than with its nearest competitor.
I would describe Auto Trader’s economic moat as a network effect. It has the largest number of sellers and buyers across its digital market, and this encourages more people to use the website. Indeed, it refers to this network effect here.
Network effects are one of the strongest types of economic moats, so this gives me confidence in its revenue and profit generation going forward.
The company’s share price had underperformed the FTSE 100 over the year to November. But recently, the stock has surged and is now up over 33% year-on-year. It was the release of the half-year results that was the catalyst behind the rally.
The company achieved its highest-ever six-month revenue and profits in the period ending in September. Consumer engagement and retailer numbers were at record levels, suggesting Auto Trader’s network effect is strengthening.
It also said it expects a strong second half of the year. It’s understandable why the share price rallied after the results.
Risks to consider for this FTSE 100 stock
Auto Trader hasn’t always been a great stock to hold over the past 18 months or so. In fact, the share price crashed hard, just as the FTSE 100 did, because of the pandemic. The price was almost 600p in February 2020, and fell to a low of 309p at one point in March.
There’s a risk of another lockdown with rising Covid cases in Europe again. Auto Trader gave big discounts to its customers over previous lockdown periods, which I think was the right thing to do in the long run. But it did severely impact its profits (profit before tax fell 37% in the fiscal year 2021) and the share price suffered for it. It’s a major risk to consider before I buy the shares.
The valuation isn’t exactly cheap either, with the shares trading on a price-to-earnings multiple of almost 30. I have to be confident in the economic moat and continued growth potential to warrant the current valuation.
The bottom line
Taking everything into account, I think Auto Trader is an excellent company, and in my view one of the best in the FTSE 100. I’ll be looking to buy the shares for 2022.
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Dan Appleby owns shares of Auto Trader. The Motley Fool UK has recommended Auto Trader. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.