As a rule, I zone in on undervalued companies, while shunning those with whoppingly high valuations. However, there are exceptions to every rule.
Sophos, so good
You wouldn’t describe security software and hardware company Sophos Group (LSE: SOPH) as cheap, trading at a mighty 61.33 times earnings. So does it merit that sky-high valuation?
Sophos sells complete IT security to more than 100m users in 150 countries, giving them end-to-end protection against complex threats and data loss. Its offers security solutions backed by its global threat analysis centre SophosLabs, which provides real-time cloud-enabled security intelligence.
The FTSE 250 company has had a barnstorming 12 months, its share price soaring 80% to 405p, which partly explains why the valuation is so high. It enjoyed a strong year to 31 March, with reported billings up 18.2% to $632.1m, and the board reporting “strong” momentum across all regions and products. The recent ransomware cyber attacks will only have boosted its profile. In fact, it mentions them in its online advertising.
On the attack
The £1.87bn company is enjoying “exceptionally strong” unlevered cash flow growth, which almost tripled to $133.4m, and has posted impressive gains in market share. Despite this, its operating loss widened over the year, largely due to cost increases associated with the strong growth in billings, as most of its revenues are deferred. However, with those deferred revenues growing 16.5% to $581m, future revenue visibility is increasing.
Sophos hiked the total dividend 156% to 4.6 cents, although the current yield is just 0.91%. The question is: when will it start making money? In the last three years, it posted losses of $54.3m, $68.4m and $49.3m, but this is forecast to turn into a profit of $34.22m in the year to 31 March 2018, then rise to $44.62m the year after. Three years of double-digit negative earnings per share (EPS) growth are forecast to reverse in the year to March 2018, with a 27% rise. This is a tempting long-term growth play, despite that pricey valuation. Cyber threats are only going to grow.
Here’s another FTSE 250-listed company trading at more than 60 times earnings, real estate investment trust Shaftesbury (LSE: SHB). It invests in property in London’s West End, and aims to produce sustainable capital growth and dividend income from its portfolio. This has built up over 30 years and includes restaurants, leisure and retail in world-renowned locations such as Carnaby, Soho, Chinatown and Covent Garden. Its 583 restaurants, cafés, pubs and shops extend to 1.1m square feet and provide 70% of current income.
It should therefore benefit from London’s status as a global tourist hub, as well as the rising and relatively affluent population across London and the South East. Its heady valuation of 68.71 times is eased by the 27.8% rise in profits after tax to £102.4m, and the firm’s promising growth prospects. EPS are forecast to rise 18% in the year to 30 September 2017, then another 13% the year after. London has already shown how it can turn Brexit uncertainties to its advantage. The share price has been becalmed lately but that could be a buying opportunity, if you can stand that heady valuation.