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2 risky growth stocks I’d probably avoid

Public Domain.

Shares of online electrical retailer AO World (LSE: AO) are trading 6% down at 136p after it released its annual results this morning. These show top-line growth of 17% to £701m from £599m last year but an increasing bottom-line loss of £7.4m compared with £6.1m.

The loss is due to expansion into Germany and the Netherlands continuing to more than eat up UK profits. The company has raised £50m since the year-end to help it build scale in Europe. But I still see risks that make this a stock I’d probably avoid.

AO let’s go

The UK is AO’s largest market and revenue here increased 13% to £630m from £559m. However, looking behind the full-year numbers, my sums say revenue slowed from 19% in the first half of the year to just 8% in the second half. This puts into sharp relief the company’s statement that it saw a “challenging trading environment” in the UK in the second half.

With inflation rising and wage growth slowing in the UK, I’m expecting things to get worse, as consumers tighten their belts and put off purchases of the white goods and computers that AO specialises in. If we ignore the lossmaking European operations, I calculate a P/E of 40 based on the UK business’s adjusted operating profit of £19.9m, no finance income or costs and a standard tax rate.

This is a high-growth P/E, which I don’t see as justified for a low-margin business in a challenging trading environment with a risk of earnings downgrades. I reckon there’s plenty of scope for the shares to fall further.

Additional risk

I suspect AO’s low margins would be even lower but for the sale of product protection plans. These plans are currently not deemed to be regulated contracts of insurance but the company says any change to this — and potentially consumer compensation claims — could have “a material adverse effect” on the group’s business and financial condition.

This risk lurking in the background is a further reason why I’d probably avoid investing in the company.

Exception to the rule?

BNN Technology (LSE: BNN) is another currently lossmaking company with a tempting growth story where the risks lead me to lean on the side of caution. The company was founded by a former stockbroker to enter the Chinese online lottery market and was floated on AIM in 2014.

A year later, the Chinese authorities placed a temporary ban on online lotteries (which still seems to be in force today). BNN launched a strategy of diversification, still within China, and in its 2016 results said: “We have pivoted to becoming a technology portal in China”.

Having raised £51m in 2016 and a further £25m so far this year, BNN has invested in various ventures from mobile phone top-ups to student-led technology start-ups. To date, it has been rather more successful at raising money from investors than building a profitable business. It’s also yet to deliver a secondary listing on the NASDAQ exchange, which it first promised for Q1 2016 and which it’s currently saying will be later this year.

Shareholders remain excited about the potential, but history shows that the vast majority of AIM-listed companies doing business in China have been disasters for investors. Will BNN prove to be one of the exceptions to the rule? It’s a risk too far for me.

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G A Chester 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.