MENU

Are these the most scarily overvalued stocks of the FTSE 250?

Public domain

The price-to-earnings (P/E) multiple for the FTSE 250 is around 20, so would you pay a multiple of over 100 for a stock from the index? That’s what buyers of Metro Bank (LSE: MTRO) and Ocado (LSE: OCDO) are paying today.

Are their P/Es simply bonkers or could there be value hiding behind the stratospheric earnings multiples?

New kid on the block

Retail and business bank Metro opened its doors in the summer of 2010, the first high street bank to open in the UK in over 100 years. The company listed on the stock market in March last year, raising £400m at 2,000p a share. Its market cap was £1.6bn and it qualified for admission to the FTSE 250.

Investors haven’t been able to get enough of Metro and the shares have climbed to 3,550p, valuing the business at £2.85bn today.

Swing to profit

Metro released its maiden annual results as a listed company last week. These showed asset growth of 64% year-on-year to over £10bn and revenue increasing 62% to £195m.

The bank made a pre-tax loss of £11.7m (excluding listing and related costs and impairment of some assets) compared with a loss of £46.6m in 2015. The reduced losses in 2016 came as the company swung to profitability in the second half of the year, posting a Q3 profit of £0.6bn, rising to £1.5bn in Q4.

The City consensus is for pre-tax profit to be pushing £30m in 2017, with earnings per share (EPS) around 30p. Therefore, at the current share price of 3,550p, the forward P/E is an eye-watering 118.

Success already in the price?

Metro’s business model is proving popular and the company has a clear road map to growth. Management is confident it can more than double its number of stores from a current 48 to 110 by 2020, as it in-fills and expands its network from its London base.

Analysts are forecasting rapid earnings growth, bringing the P/E down to below 50 for 2018 and to 27.5 by 2019. It looks to me like the market is pricing the business for guaranteed success, so I’m not surprised that more than half the analysts covering the stock reckon investors have got ahead of themselves and that the shares are currently too highly valued.

Expensive grocer

Online grocer Ocado released its annual results last month. These showed a rise in revenue to £1.27bn from £1.11bn, with pre-tax profit (excluding exceptional items of £2.4m) increasing 21.8% to £14.5m from £11.9m.

The company is paying little in the way of tax at the moment, due to past losses but on the basis of a standard tax rate, I calculate EPS as 1.95p. At a share price of 249p, this gives a P/E of 128. Even if we look ahead to analysts’ forecasts for 2019, the P/E is still over 50.

Something has to happen

I put Ocado’s high rating down to the company’s “continued discussions with multiple international retailers regarding adoption of Ocado Smart Platform solution”. However, these discussions have been going on for years — literally — without a single deal being reached, despite management’s perennial “confidence”.

Based on Ocado’s existing business, I can only see its P/E as bonkers. For the company’s shares to make any significant headway, something surely needs to happen in the way of deals with international retailers. And any such deals would need to be pretty tasty to justify the current rating.

Looking for a growth stock to buy today?

If you're in the market for growth stocks, but agree with me that Metro and Ocado look too pricey today, you may want to check out a company that the Motley Fool's experts have identified as A Top Growth Share.

The company in question has already delivered a 400% return in five years and is expertly analysed in this FREE without obligation report.

Simply CLICK HERE for your copy, but hurry, it's available for a limited time only.

G A Chester has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.