Did David Jones Limited make too much money?

David Jones has been in the news for all of the wrong reasons lately. Under Mark McInnes, the company was making impressive profits. But did those profits come at the expense of the long-term health of the business? Were David Jones making too much money?

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

David Jones Limited (ASX: DJS) has been in the news for all of the wrong reasons lately.

It's been the poster child for the theory that traditional retail is dying at the hands of the internet, its sales have been declining, and now the current and former CEOs are trading verbal blows about who is responsible for the situation in which the company now finds itself.

The drama started with an interview current David Jones CEO Paul Zahra gave to the Australian Financial Review. Among other things, Zahra highlighted some of the company's past missteps, including not persisting with an online shopping strategy, and under-investing in the company's retail 'point of sale' system.

Immediate-past CEO Mark McInnes took umbrage at what he saw as personal criticisms, specifically accusing his successor of 'rewriting history'.

This vignette brings to mind a key consideration investors should bear in mind before investing in a company (or when considering whether to remain invested in that company).

Profits can be too low…
Paul Zahra's comments go to a situation in which investor diligence and thoughtful consideration is important.

In essence, Zahra is suggesting that David Jones has allowed its business infrastructure to become dated, and that the company should have upgraded some of that infrastructure before now, as well as suggesting the company should have persevered with its online initiatives.

Those types of management decisions are – by necessity – a judgement call.

As a shareholder, you don't want management spending money recklessly on the latest fad or over-investing in unproven technologies. The result, more often than not, is that cash which otherwise would have filled the company's coffers is frittered away, and the company will report lower profits.

…and too high
There is, however, another side to this coin. It is possible for management to – with the best of intentions – delay spending on critical infrastructure beyond a reasonable timeframe. Letting machinery run down through poor maintenance or letting brand equity erode through insufficient advertising are two simple examples. The company looks more profitable in the short term – all of that money saved on maintenance activities can be added to the profit line on the P&L.

However, just as skipping low-cost car maintenance now can mean a bigger bill later, a lack of investment in company 'maintenance' in the short term may just be delaying the inevitable. In that event, investors who are used to seeing a higher profit number may get a rude shock when the day comes for the company to spend up big to fix the problems that have accumulated during those years.

Judgement call
I don't know with any certainty who is right in this current war of words. Paul Zahra understandably wants to put the past behind him and start with a clean slate. Part of that process is outlining the key changes the new CEO is planning to make, and explaining why the costs will be incurred this year. If you've shopped in DJs recently, you'll know that the cash register system doesn't seem to have been upgraded for many years.

Equally, Mark McInnes is rightly proud of the turnaround David Jones achieved under his stewardship, and doesn't want to see his legacy tarnished. He believes the decision to shutter the loss-making internet site was the right thing to do when the company was in difficult financial times and that the current challenges shouldn't be blamed on past management.

Foolish take-away
When a company's profits fall, the numbers tell investors a very black and white story. The declines galvanise both management and shareholders, and hard questions are asked. Human nature being what it is, we tend not to take the same approach when times seem better. We don't ask the hard questions when profits are up, instead often congratulating management for good results and ourselves on our good judgement.

Sometimes, those increased profits can come at the expense of investments that underpin the ability of the organisation to continue to succeed and grow. Next time one of your companies turns in a good profit performance, do yourself a favour and ask yourself 'is my company making too much money'. It's counter-intuitive, but that's precisely why it's the right question to ask.

Are you looking for more quality stock ideas? Motley Fool readers can click here to request a new free report titled The Motley Fool's Top Stock For 2012.

More reading

Scott Phillips is The Motley Fool's feature columnist. Scott owns shares in David Jones. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson

More on ⏸️ Investing

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest
ETFs

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

Two people in suits arm wrestle on a black and white chess board.
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »

⏸️ Investing

Why Fox (NASDAQ:FOX) might hurt News Corp (ASX:NWS) shareholders

News Corporation (ASX: NWS) might be facing some existential threats from its American cousins over the riots on 6 January

Read more »