Would I be mad to buy shares in WH Smith after news of an accounting irregularity?

The best time to buy shares is often when they’re trading at a discount. But sometimes there are good reasons why stocks fall sharply.

WH Smith‘s (LSE:SMWH) stock crashed 42% on Thursday (21 August). I don’t think a £30m error justifies a £570m drop in the company’s market value, but that might not be the end of the issue.

What’s the problem?

The issue is the way WH Smith accounts for rebates and incentives from suppliers. Instead of spreading these over the life of the contract, it had booked them all immediately. As a result, the company’s profits for this year are set to be much lower than expected. The savings are real, but they’re coming in future years, not the current one.

Given this, I don’t think the issue justifies the huge drop in the company’s share price. But the bigger concern is the problem might not be confined to one error. WH Smith has hired Deloitte to investigate the situation. It’s the right thing to do. But as a shareholder, I’m holding my breath that nothing else turns up.

Déjà vu

For UK investors, the situation with WH Smith might have a familiar feel. At the end of last year, FTSE 250 housebuilder Vistry uncovered costing issues in one of its divisions. The firm hired an independent auditor to assess the situation, which led to two further profit warnings. As a result, the stock fell over 50% in 2024 and hasn’t yet recovered.

Exactly what Deloitte might uncover when they look at WH Smith’s books is almost impossible to predict. And this highlights the inherent risk when it comes to investing. 

It’s almost impossible for ordinary retail investors to be able to anticipate things like accounting irregularities. But what we can do is focus on the things that are available to us. 

What’s changed?

There’s a lot of uncertainty around WH Smith at the moment and that’s why the stock is falling. But there’s still a lot that’s still the same about the underlying business.

The company has recently sold off its high street stores to focus on hospitals, airports and train stations. These are attractive markets where competition’s limited and this hasn’t changed.

Furthermore, demand in these areas is reasonably strong. As long as the macroeconomic picture remains positive, there’s likely to be a captive audience for the firm to sell to. 

Obviously, the big question is what that’s worth. And there’s more uncertainty around that than usual, so I can absolutely understand investors staying away. 

What I’m doing

Based on its revised earnings, WH Smith’s big fall means the stock’s trading at a price-to-earnings (P/E) ratio of just over 7. And I think this is cheap given the company’s competitive position. 

Obviously, the results of the investigation could uncover more issues that could change the equation. But my view is that the stock market’s currently pricing in another profit warning. 

That’s not to say the stock won’t fall further if more bad news shows up, but I think the current share price already reflects this. So while it’s risky, I’m looking to buy the next time I get a chance.

The post Would I be mad to buy shares in WH Smith after news of an accounting irregularity? appeared first on The Motley Fool UK.

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Stephen Wright has positions in WH Smith. The Motley Fool UK has recommended WH Smith. 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.

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