Despite experiencing a challenging first half of the year, manufacturer of actuators and flow control units Rotork (LSE: ROR) has posted a 2% rise in its share price today. Part of the reason for this is optimism regarding the acquisition of a unit (M&M International) of engineering peer, Spirax-Sarco, for just under €10m in an all cash deal.
Of course, Rotork’s pretax profit fall from £61m to £56m between the first half of 2014 and the first half of 2015 was largely due to challenges faced in the oil and gas industry. With the oil price being lower and expected to be for some time, a number of projects have been deferred or cancelled by oil explorers and producers, which has had a detrimental effect on the performance of Rotork. And, looking ahead, things are unlikely to dramatically improve.
That’s because Rotork is expected to grow its bottom line by just 2% next year. Clearly, this would be a disappointing rate of growth and, even if the oil price does rebound between now and the end of 2016, oil sector companies are unlikely to ‘turn the taps on’ with regard to capital spending, since they are likely to be nervous about downward movements in the price of oil. As such, there seems to be little justification for Rotork to have a price to earnings (P/E) ratio of 18.1 and, therefore, it seems likely that its share price will come under pressure over the medium term.
Similarly, high-street baker Greggs (LSE: GRG) also trades on a rating that is difficult to justify. Certainly, its strategy is very sound and it is focusing on the core elements of what made Greggs successful in the first place; good value food in convenient locations. And, as has been seen in recent years, the closing of unprofitable stores has had a positive impact on Greggs’ bottom line, with its net profit rising by a whopping 43% last year. And, looking ahead, further earnings growth of 18% this year and 7% next year is currently being pencilled in by the market.
However, with Greggs trading on a P/E ratio of 25.3, it appears to be hugely overvalued. In fact, it has a price to earnings growth (PEG) ratio of 3.6, which is difficult to justify given that it is not a particularly defensive stock. As such, the 80% share price growth year-to-date may not be repeated in future.
Of course, some stocks do deserve higher ratings. That’s especially the case if they offer a potent mix of defensive attributes and strong growth prospects. One such stock is beverage company Diageo (LSE: DGE). It is expected to grow its earnings by just 5% this year, but is suffering from weak demand in emerging markets, with China in particular continuing to disappoint.
However, in the long run Diageo has huge potential, with its vast exposure to the developing world likely to mean a rapid rise in sales and earnings as the middle class grows and demands more premium alcoholic beverages. As such, and while Diageo has a P/E ratio of 19.2, it appears to be well-worth buying at the present time.
