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

Is there hidden value in these FTSE 250 (INDEXFTSE:MCX) stocks or are their P/Es of over 100 simply bonkers?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

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.

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.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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.

More on Investing Articles

Black woman using loudspeaker to be heard
Investing Articles

I was right about the Barclays share price! Here’s what I think happens next

Jon Smith explains why he still feels the Barclays share price is undervalued and flags up why updates on its…

Read more »

Investing Articles

Where I’d start investing £8,000 in April 2024

Writer Ben McPoland highlights two areas of the stock market that he would target if he were to start investing…

Read more »

View of Tower Bridge in Autumn
Investing Articles

Ahead of the ISA deadline, here are 3 FTSE 100 stocks I’d consider

Jon Smith notes down some FTSE 100 stocks in sectors ranging from property to retail that he thinks could offer…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

Why I think Rolls-Royce shares will pay a dividend in 2024

Stephen Wright thinks Rolls-Royce shares are about to pay a dividend again. But he isn’t convinced this is something investors…

Read more »

Investing Articles

1 of the best UK shares to consider buying in April

Higher gold prices and a falling share price have put this FTSE 250 stock on Stephen Wright's list of UK…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

The market is wrong about this FTSE 250 stock. I’m buying it in April

Stephen Wright thinks investors should look past a 49% decline in earnings per share and consider investing in a FTSE…

Read more »

Black father and two young daughters dancing at home
Investing Articles

1 FTSE 250 stock I own, and 1 I’d love to buy

Our writer explains why she’s eyeing up this FTSE 250 growth phenomenon, and may buy more shares in this property…

Read more »

View of Tower Bridge in Autumn
Investing Articles

The FTSE 100 is closing in on 8,000 points! Here’s what I’m buying before it’s too late!

As the FTSE 100 keeps gaining momentum, this Fool is on the lookout for bargains. Here's one stock he'd willingly…

Read more »