Time to take a fresh look at these smoking hot growth stocks?

Both of these growth stars trade on sky high valuations. Are they still justified?

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Based on last week’s news that nearly half of all UK businesses were victims of at least one cybersecurity breach or attack in the last year, it goes without saying that the services of companies offering protection in this and related areas are now firmly in demand. 

With the shares of some now trading on sky-high valuations however, does it make sense to consider buying them? Let’s take a look at two examples.

Way ahead

After a “very strong end” to the period, network security solutions provider Sophos (LSE: SOPH) now expects constant currency billings growth in Q4 of roughly 27%. That’s before any upside from malware threat detecting specialist Invincea — its most recent acquisition — is taken into account. For the whole year, this figure is expected to be around 20%.

Reported billings by the end of March are expected to have grown to $630m — 18% more than the previous year. That’s way ahead of the predicted $610m-$617m. As a result, cash EBITDA and unlevered free cash flow will also be ahead.  

That all sounds very positive. Trouble is, after a huge 86% rise in shares since the aftermath of the EU referendum (including 19% since the aforementioned update was issued in early April), Sophos now looks priced to perfection. While there’s nothing to say that this rise can’t continue before final results on 17 May, I would expect to see at least a degree of profit-taking fairly soon. After all, even a forecast 60% rise in earnings per share for 2018 still leaves the stock trading on a vertigo-inducing 49 times forward earnings.

Despite being significantly lower than a few years ago, the £214m of remaining net debt on its balance sheet is also not something I really like to see.

Rebounding strongly

While not so highly valued, shares in £456m cap identity data intelligence specialist GB Group (LSE: GBG) still trade on 35 times 2017 earnings thanks to its growth prospects.

Last week’s positive update on performance for the year to the end of March revealed that the Chester-based company now expects to report a 27% jump in adjusted operating profits (to £17m) compared to the previous year — more than the market was expecting. Revenues are also expected to be up by 19%.

Although 40% less when compared to the previous year, the company’s net cash levels were still a very healthy £5.2m at the end of March; the drop being the result of dividends paid to shareholders and settlements of earn-outs on acquisitions (where the seller receives additional payments based on future performance).

GB Group will announce its final results on 6 June. Given the optimism expressed in last week’s update, the shares could quite reasonably continue climbing over the next six weeks. Nevertheless, since some investors will have snapped up the stock when it dipped as low as 216p back in November, don’t be surprised if some head for the exits either before or immediately after the numbers come in. A 57% return in just six months isn’t to be sniffed at.

Bottom line

Despite their high growth credentials, I’m not sure that now is the best time to be considering opening a position in either Sophos or GB Group. That said, should macroeconomic or political events cause markets and the share prices of both companies to temporarily slide again, investors could be presented with another golden opportunity.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Paul Summers 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.

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