Are these high-flyers heading for a crash?

Bilaal Mohamed considers whether these two soaring shares could be heading for a crash.

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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.

Shares in chip designer Imagination Technologies (LSE: IMG) have more-than-doubled since the start of 2016, rising from lows of just 105.5p last January to today’s levels of around 240p. So should investors ditch their holdings for fear of a severe market correction, or should they hold on for further long-term gains?

Share price collapse

You may be surprised to hear that I don’t see Imagination Technologies as being over-bought, even after the recent 100% share price gain. That’s because, if you take a step back, you’ll see that the shares have barely started to recover from the massive collapse that began in 2012 when the business traded above 700p before tumbling to last year’s lows.

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The small-cap technology firm has suffered from a decline in both revenues and profits in recent years, culminating in a significant pre-tax loss of £63.21m for the last financial year to March 2016. Revenues declined 23% to £120m as the group suffered from a significant slowdown in the semiconductor market, driven by weaker smartphone sales and a build-up of inventory in China.

Restructuring programme

Management have now successfully executed a significant restructuring programme, which it initiated last February, on time and in line with expectations. Cost savings of £27.5m have been delivered, enabling the business to return to profitability in the first half of the current financial year.

I think the recent share price gains reflect a more optimistic view of the company’s future following the restructuring, and I personally believe this to be a transformational year for the group. Meanwhile in the City, analysts are also predicting a far rosier future for the technology firm with consensus estimates suggesting a swing to pre-tax profits of £20m for fiscal 2017, and a return to revenue growth for the first time in three years.

Despite the recent share price surge, the company’s valuation still looks appealing to me, with double-digit earnings growth forecasts over the next two years bringing the P/E ratio down to 23, well below historical levels. I would continue to buy on the dips for long-term growth.

Recurring income

Another London-listed firm that’s been flying high recently is support services group Diploma (LSE: DPLM). The FTSE 250-listed company is an international group of businesses that supplies specialised technical products and services to the Life Sciences, Seals and Controls industries. Diploma’s businesses are focused on supplying essential products and services that are funded by the customers’ operating budgets rather than their capital budgets, providing recurring income and stable revenue growth.

The group has made a robust start to the year with revenues in Q1 to December 31 increasing by 23%, helped by the depreciation of sterling. The company’s share price has soared over the past year, gaining more than 50%, but I still think there’s plenty more room for further growth. However, at 22 times forward earnings, the shares aren’t cheap, and growth-focused investors would be best advised to wait for a pull-back and buy on weakness.

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

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