Over the month of August many of the ASX listed shares reported results. In some cases, share prices fluctuate significantly after a company results. We take a longer-term view at Morningstar. Based on these results our analysts updated their view of the companies in our coverage universe. Our analysts are focused on the long-term direction of a business and its competitive position.

One earnings report or set of guidance doesn’t usually lead to a meaningful change in what they think a business is worth.

Investors have the tendency to chase performance. And we should stop. This is one of the primary reasons why Morningstar’s Mind the Gap study shows that investors underperform the investments in their portfolio by 1.7% a year. Read more about how to improve your performance by making better decisions.

Even the best companies can reach valuation levels that limit the prospects for future returns. Valuation levels represent investor expectations for the future. If those expectations are too high they can become impossible to meet.

While we think you should avoid these shares if you don’t own them that doesn’t mean you should sell them if they are already in your portfolio. Read our article on when to sell shares. 

Below are 2 shares to avoid after results season based on their valuation levels.

Goodman Group (GMG)

  • Economic Moat: Narrow
  • Fair Value Estimate: $24 per share
  • Star Rating: ★
  • Uncertainty rating: Medium

Goodman Group shares have risen over 45% in the past year. Investors are clearly enthused with the real estate investment trust’s (“REIT”) expansion into the data centers needed to support AI. This is a compelling narrative. AI requires increased computing power to run AI models. More computing power means more data centers. Investors are betting that owning these data centers is the pathway to riches.

Narrow-moat Goodman Group’s fiscal 2024 results were broadly in line with our expectations. Operating earnings per security grew 14% to 107.5 cents, up from 94.3 cents last year, above guidance of an 11% increase. Unfranked distributions of $0.30 per security were flat year on year. The company guides to operating earnings rising 9% in fiscal 2025, and our estimate of $1.17 is in line. However, guidance is for distributions per security to be unchanged at $0.30, which equates to a forward yield of less than 1%. Payout ratios will likely remain low in the near term, given the large development pipeline.

We maintain our fair value estimate of $24 per security, with our longer-term forecasts broadly unchanged. At current prices, the securities look materially overvalued. We think this is likely due to many investors taking a more optimistic view on the demand for data centers to support cloud computing and artificial intelligence training by major technology companies.

However, we remain more cautious. Data centers may not need to be located in inner-urban areas where Goodman typically owns properties, as access to energy, water, and land may prove to be more important than the low internet latency often achieved in inner-urban areas. As it becomes increasingly more difficult to continue securing energy contracts on terms as attractive as its current power bank, Goodman's profitability in developing these centers may be constrained.

Goodman is increasingly focused on data centers rather than traditional industrial warehouses. As the development pipeline skews toward these larger-scale, more complex, and higher-value data center projects, we assume marginally lower completions in the near term than we previously forecast, with higher completions in outer years, as these projects are likely to take longer to complete.

Business strategy and outlook

Goodman Group is one of the world’s premier developers and managers of industrial property projects and investments. The group was co-founded in Australia by Gregory Goodman who remains CEO, and now has projects and customers in Asia, Europe, and the Americas.

A typical project involves obtaining a development site, signing tenants onto leases, and attracting investors who pay for the development and buy the completed project. Goodman typically retains a minority stake and continues to manage sites after completion, collecting development fees, leasing fees, management and performance fees, and a share of rent.

The group’s development pipeline has grown substantially, driven by the race to build e-commerce capability, modernize supply chains, and strong demand for data centers. Most of the group’s development projects end up in Goodman managed investments, boosting the group’s assets under management. We expect this to continue for the next few years as the race continues for the best logistics and data center sites, closest to transport links and the end consumer, and with power secured, which is necessary for data centers. Goodman should benefit from its expertise, and its legacy holdings of property, many of which are close to urban centers and key infrastructure, and therefore more attractive than outlying greenfield industrial sites.

However, we expect the remarkable returns to eventually slow down to a more modest level. First, there is only so much existing property that can be sold and developed, before new sites need to be acquired, likely at substantially higher prices. Second, we see much greater competition in future as many rivals are growing their presence in industrial property. GPT sold its stake in iconic office building 1 Farrer Place, with its rationale in part to rotate more capital into industrial property. Likewise Dexus, Charter Hall, Mirvac, Stockland, Growthpoint, and Cromwell are all eyeing opportunities in the sector, plus Goodman must contend with major overseas players such as Prologis and others.

Goodman bulls say

  • Investment in industrial property remains high as retailers invest in e-commerce and logistics, and alternative uses such as residential and data centers add appeal.
  • Global capital is still chasing exposure to property, and particularly industrial property given strong rental growth at present.
  • New fund inflows add to Goodman Group’s fee revenue. Although it is not risk-free, long lock-ins on its funds management vehicles bestow annuity-like characteristics to this revenue.

Goodman bears say

  • Falling interest rates, and strong demand for industrial property from investors and tenants helped Goodman Group. It remains to be seen how Goodman will manage the headwinds of higher interest rates and potentially lower demand for industrial property.
  • Rival REITs and others are competing to acquire industrial property and establish funds management businesses.
  • Goodman Group’s global portfolio is exposed to risks such as trade tensions, onshoring, and protectionism, all of which could force supply chains to evolve, which may not favor its projects.

Woolworths Group (WOW)

  • Economic Moat: Narrow
  • Fair Value Estimate: $28.50 per share
  • Star Rating: ★
  • Uncertainty rating: Low

A challenging trading environment took its toll on narrow-moat Woolworths in fiscal 2024. Group earnings declined 1% on the previous corresponding period, or PCP. Fiscal 2024 net profit after tax of $1.7 billion was in line with our estimate, and our earnings forecasts are mostly unchanged. We lift our fair value estimate by 4% to $28.50, largely reflecting the time value of money. Shares screen as overvalued. We believe a P/E of 26 at current prices and based on our fiscal 2025 earnings estimate is too expensive for a relatively low-growth, defensive yield stock. We forecast a five-year EPS compounded annual growth rate (“CAGR”) of 5%.

At the segment level, the core Australian food business that generated over 90% of operating earnings surprised us on the upside. Conversely, the relatively smaller segments disappointed.

Similar to no-moat Coles, Woolworths’ Australian food business expanded gross margins enough to offset a 6% increase in wages, elevated energy prices, and higher rents. Australian food earnings before interest and taxes (“EBIT”) margins increased slightly, up 10 basis points to 6.1%.

Gross margins increased by almost 80 basis points on the PCP, compared with the 50-basis-point uplift at Coles. At Woolworths, too, a positive mix shift to higher-margin nontobacco sales, less discounting, and more advertising revenue lifted margins. But contrary to Coles, which had been grappling with elevated theft levels in the first half of the year, lower stock loss was an immaterial contributor to Woolworths’ gross margins in fiscal 2024.

We expect Australian food EBIT margins to decline by 50 basis points to 5.6% in fiscal 2025.

Business strategy and outlook

Woolworths is one of Australia's largest retailing groups, operating supermarkets and discount department stores. Its market capitalization is around $45 billion, with annual sales of around $70 billion.

Woolworths has a narrow economic moat characterized by an extensive supermarket store network, serviced by an efficient supply chain operation coupled with significant buying power. It operates in the very competitive supermarket and discount department store segments of the retail sector. Intense competition has taken its toll on margins. Management has reset prices lower to drive foot traffic and increase basket sizes. Volume growth is vital for maximizing supply chain efficiencies.

To contextualize Woolworths' enormous scale advantage, its Australian food sales of over $50 billion represented about 13% of total Australian retail sales in fiscal 2024.

Key risks involve increased competition in the Australian retail landscape and reduced consumer spending. The change in ownership of Australia's largest retailer, Coles, in 2007, was the catalyst for increased price competition by both groups to win market share, while the entry of Amazon Australia could raise the competitive bar in the future.

The aggressive expansion of low-cost discounter Aldi has altered and further segmented the grocery sector and increased competitive pressure. A reduction in the rate of growth in consumer spending would affect revenue growth and could affect operating margins. Increased frugality and heightened deflationary pressures would crimp top-line sales growth, and relatively high fixed-cost leverage would affect margin.

However, Woolworths is well positioned to withstand cyclically weak consumer spending. Woolworths is a defensive stock, with food retailing generating most of group revenue and profit, a solid balance sheet, and a narrow moat surrounding its economic profits.

Woolworth bulls say

  • Woolworths' dominant position in the supermarket sector is entrenched and, coupled with first-class management, suggests it can maintain leadership in the sector.
  • Woolworths' operating leverage could lead to a rebound in operating margins, driving cash generation that funds expansion and acquisitions while allowing capital-management initiatives.
  • The refurbishing of the existing supermarket fleet and rollout of revised store formats with significantly improved service, convenience, and product offerings could increase store productivity and lead to higher sales growth.

Woolworth bears say

  • Strong online sales growth reduces store productivity and could weigh on operating margins at some retailers, including Woolworths.
  • Increased competition from Coles, an aggressive Aldi, and independents serviced by Metcash is likely to keep competitive pressures elevated and constrain operating margins.
  • Having exited petrol retailing as well as the liquor and hotels categories, Woolworths is less diversified and depends on the fortunes of its supermarket businesses in Australia and New Zealand.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn more about how to identify companies with an economic moat, read this article by Mark LaMonica.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.