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These 2 growth stocks could be about to crash

Image: The Motley Fool Editorial.

I think it’s safe to say that shareholders of British engineering firm Renishaw (LSE: RSW) have enjoyed a nice easy ride over the last few years, with an astounding 1,179% share price increase since 2009. The company’s shares are now trading near all-time highs after another 34% growth spurt since December pushed the share price to record levels last month. So should shareholders be bracing themselves for a sharp retracement very soon?

Promising start to the year

The Gloucestershire-based group is one of the world’s leading engineering and scientific technology companies, with expertise in precision measurement and healthcare. The company’s last set of full-year results were somewhat disappointing with a 44% slump in pre-tax profits to £80m, and a £58m decline in revenue to £436.6m, as a result of a drop in Asian orders.

The current financial year looks a lot more promising, with first-half results showing a 21% rise in revenue to £240.4m, compared to £198.5m for the same period a year earlier. Pre-tax profits also came in higher at £35.7m, compared to £28.6m for the first half of FY2016. It was particularly encouraging to see revenue growth in all of the company’s geographical regions, and in particular Asia, with a 27% improvement to £108.7m.

Heady valuation

The UK also put in a good performance seeing a 20% rise in revenue to £13.2m, with Europe not far behind on an 18% improvement to £52.1m. The Americas region lagged a little behind with 11% revenue growth from £43.7m to £48.6m. The group also enjoyed a nice uplift in pre-tax profits during the first six months of the fiscal year, rising by 25% from £26.5m to £35.7m.

I think the long-term outlook is bright for Renishaw as it continues to drive future growth through innovative and patented products and the ability to provide local support in its expanding global markets. But frankly I’m concerned about the heady valuation. After soaring 72% over the past year, the shares are now trading at 28 times forecast earnings for the current year to June, well above the five-year average of 18. I fear a sharp retracement could be on the cards sooner rather than later.

Flying too high?

Another mid-cap firm that I believe could be heading for a significant correction is BBA Aviation (LSE: BBA). The FTSE 250-listed aircraft services provider last month revealed an $82.2m pre-tax loss for 2016 as it reported $316m in exceptional items for the year. However, underlying pre-tax profits increased from $149.7m to $238.7m, with underlying operating profit up 63% to $330.1m. Group revenue increased by 25% to $2.1bn, with a healthy $558.7m contribution from acquisitions.

The medium-term outlook seems very promising with analysts anticipating a 21% uplift in earnings for the current year to December and a further 9% improvement pencilled-in for 2018. But after a 58% share price increase over the past 12 months, the group’s shares are beginning to look expensive at 16 times earnings for 2017, well above par relative to historical levels. I think BBA Aviation could be flying too high and a market correction could be looming.

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Bilaal Mohamed has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended BBA Aviation. The Motley Fool UK has recommended Renishaw. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.