These small-cap growth stocks look dangerously overvalued

Bilaal Mohamed thinks at least one of these fashion retailers could be in danger of a horrible correction.

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It’s been just over a year since Joules Group (LSE: JOUL) was floated on the London Stock Exchange, and what a year it’s been. Investors were certainly quick off the blocks as the shares rocketed from their IPO price of 160p per share to highs of 286p earlier this week. With a market capitalisation of £260m, last May’s £140m floatation seems but a distant memory. But are the shares still attractive after their meteoric rise, or should investors be wary of the premium valuation?

Quintessentially British

If like me you’re somewhat fashion-challenged and can’t distinguish your Primark from your Prada, then all you need to know is that AIM-listed Joules is one of those founder-led fashion retailers (think Ted Baker) that has carved out a strong niche for itself over the years. The Market Harborough-based group is able to sell its country-inspired premium -branded clothing to the likes of Wills and Kate, as well as overseas customers who may be fans of all things quintessentially British – whatever that means.

Niche it may be, but Joule’s growing popularity means it now sells its branded clothing, footwear, accessories and homewares, from 107 stores in the UK and Republic of Ireland, with an established e-commerce platform and a fast growing international presence. Last year the group boasted a 41.5% surge in underlying pre-tax profits to £7.5m, driven by a 12.8% rise in group revenue to £131.3m.

Wait for it

Whether the group can repeat, or even surpass that stellar performance for FY2017 remains to be seen, but this morning’s trading update gave us some strong clues as to what we can expect from next month’s full-year results.

In its first full financial period since admission to AIM, group revenues increased by 19.6% to £157m for the 52-weeks to 28 May 2017. As a result of the strong revenue growth, anticipated improvement in gross margin, and continued cost discipline, management now expects pre-tax profits for fiscal 2017 to be comfortably ahead of previous expectations. The market reacted favourably to the news lifting the share price 5% by mid-afternoon.

I continue to see Joules as a great long-term buy, but with the shares priced at 30 times earnings I would be inclined to wait for a pull-back.

No longer a secret

Meanwhile, at the other end of the market, affordable online fashion retailer (LSE: BOO) has enjoyed even greater success over the past 12 months. The company’s shares have soared by a staggering 285% over the past year, making it the second-largest company traded on the Alternative Investment Market, behind online rival ASOS. With a market value in excess of £2.4bn, I would say is no longer Manchester’s best kept secret.

Fiscal 2016/17 was a truly momentous year for the group, with pre-tax profits almost doubling from £15.67m to £30.95m, and revenues soaring 51% to £294.6m. Furthermore, the acquisition of PrettyLittleThing and the Nasty Gal brand earlier this year represent a step change in the size, structure and operation of the group, and should greatly enhance future growth and profitability.

That said, I’m still very concerned about the valuation. With an eye-watering P/E rating of 84 I feel the share price has pushed too far ahead. My fear is that any failure to live up to the huge growth expectations over the next few years could bring the shares crashing down to earth with a painful bump.

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.

Bilaal Mohamed has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended ASOS. The Motley Fool UK has recommended 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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