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2 overvalued dividend stocks with downside risk

Image: Moss Bros: Fair use

With the FTSE 100 having recently reached an all-time high it’s perhaps unsurprising that some stocks now appear to be overvalued. Certainly, dividend shares could become increasingly in-demand among investors seeking to overcome the challenge of rising inflation. However, if a company’s growth potential and rating appear to be difficult to justify, it may be prudent to avoid them. Here are two such companies which appear to fall neatly into that category.

Difficult outlook

Reporting on Friday was menswear retailer and hire specialist Moss Bros (LSE: MOSB). It reported an improvement in trading in the first 15 weeks of the year, with sales increasing by 3.7%. Sales growth of 2.3% on a like-for-like (LFL) basis was also encouraging, and shows that the company’s strategy is working well. E-commerce sales growth of 14.7% suggests that the company is adapting to changing consumer tastes, with 11.6% of sales now being online.

Looking ahead, Moss Bros is now entering its peak trading season, with weddings, Ascot and school proms set to take place over the coming months expected to provide a boost in performance. But with its bottom line due to rise by only 6% this year and by a further 5% the year after, its share price growth could be somewhat limited. That’s especially the case since the company’s shares trade on a price-to-earnings growth (PEG) ratio of 3.2.

With inflation moving higher and wage growth slipping back, consumer spending levels may fall over the short run. This could lead to lower-than-expected sales growth for retailers such as Moss Bros. Therefore, it would be unsurprising for its forecasts to be downgraded to at least some degree, which may lead to a declining share price. Since dividends are not covered by profit, this could put its 5.6% dividend yield under pressure.

High valuation

Also reporting on Friday was the UK’s largest listed residential landlord Grainger (LSE: GRI). It reported a rise in adjusted earnings of 39% in the first half of the current year. Net rental income has risen by 11%, with the company becoming more efficient and focused during the period.

Grainger is looking ahead to more growth as it believes the private rented sector growth opportunity is compelling and offers strong investment fundamentals. It anticipates the strong momentum of the first half of the year to continue now that it has secured £439m of private rented sector investment, half of its £850m target.

While Grainger’s long-term outlook may be positive, its near-term growth potential appears limited. For example, in the next financial year it is expected to report a rise in earnings of just 6%.

Despite this, Grainger has a relatively high valuation. It trades on a price-to-earnings (P/E) ratio of 21.5, which suggests there is only a narrow margin of safety on offer. As such, its share price could come under pressure and mean that, aside from a forecast dividend growth rate of 17% next year, there are no positive catalysts to push its share price higher.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.