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Why these FTSE 250 dividend stocks are set to go into reverse

Halma. Fair use.

No stock can ever rise continuously. Inevitably, a weak trading update, overvaluation or an external difficulty will cause its share price to fall. Sometimes this can lead to a buying opportunity, while at other times it can mean the company is worth avoiding. Here are two stocks that could be due to suffer falling share prices in the near term.

High price

Reporting on Thursday was safety, health and environmental technology company Halma (LSE: HLMA). Its trading update showed that it is making solid progress and is on target to meet expectations for the full year. Encouragingly, it has recorded organic constant currency revenue increases in all major geographic regions. UK growth has remained steady, while Asia Pacific has continued to deliver strong growth.

While this is good news for the company’s investors, its current valuation appears to be rather high. Halma’s shares have risen by 13% since the start of the year and now trade on a price-to-earnings (P/E) ratio of 25.4.  A higher P/E ratio can often be justified when a company’s forecast growth rate is also relatively high. However, in Halma’s case it is expected to record a rise in its bottom line of 9% next year and 6% the year after. This puts it on a price-to-earnings growth (PEG) ratio of 3.4.

Although the company could prove to be a solid investment in the long run, it appears as though investor sentiment may have become overly upbeat in recent months. Therefore, it may be a stock to avoid in favour of better value opportunities elsewhere.

Risky business

AO World (LSE: AO) has been a major success story of recent years. It has grown exceptionally quickly to become one of the major names in domestic appliance retailing. However, since listing in February 2014, its share price performance has been anything but impressive. It has lost 60% of its value, but the company still appears to be too expensive to warrant buying into at the present time.

The main reason for this is the state of the UK economy. This year is shaping up to be one of the most challenging in recent memory for retailers. Therefore, there is a good chance that downgrades to earnings outlooks will take place during the course of the year. Investors may therefore favour companies that are already highly profitable and which offer relatively low valuations.

AO World is currently loss-making and this may cause investor sentiment towards the company to come under pressure. It is forecast to move into profitability next year, but its forward P/E ratio using next year’s forecasts stands at 255. This indicates that the market has already factored in the company’s growth in the next financial year.

This does not necessarily mean a major slump in its share price. But at a time when other retailers trade on super-low valuations and yet are highly profitable, it does mean there may be better investment opportunities available elsewhere.

Growth potential

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