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Why I’d dump growth stock Fevertree Drinks plc today

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Fevertree Drinks plc (LSE: FEVR) has experienced a stunning share price rise. The developer and supplier of premium mixer drinks has recorded a capital gain of 90% in 2017, which takes its gain since the November 2014 IPO to almost 1,200%.

Clearly, it has been an exceptional period for investors in the stock, and it may feel as though the company’s valuation will keep rising in perpetuity. However, that is unlikely to be the case. It now has a valuation which means it may be worth selling, rather than buying, at the present time.

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Growth potential

Of course, Fevertree has a dominant position within its key markets. It is viewed by many consumers as selling the best mixers in the world. This strength of customer loyalty means that its sales growth is likely to remain robust over the medium term, since consumers are likely to stick with their favourite brand of tonic water or ginger ale, for example.

Strong customer loyalty may also mean that the company has a high degree of pricing power. This may allow it to improve on its current margins, thereby helping profit growth to exceed sales growth over the medium term. Certainly, there is a danger that consumer tastes will change and certain types of alcoholic beverages will come in and out of fashion. However, with tonic water, ginger ale and lemonade being highly adaptable mixers, Fevertree is likely to offer resilient sales numbers over the long run.

High valuation

While it has a sound business model and could perform well as a business, the market seems to have fully priced-in its future growth potential. It is expected to report a rise in its bottom line of 16% in the current year, followed by further growth of 12% next year. However, it trades on a price-to-earnings (P/E) ratio of 91. This means it has a price-to-earnings growth (PEG) ratio of 6.5 at the present time. Even for a business with a sound outlook, such a high valuation is incredibly difficult to justify.

Another ‘sell’

Another stock which may be worth selling rather than buying right now is global engineering and strategic, technical and environmental consultancy business Ricardo (LSE: RCDO). It reported the acquisition of US-based full-service engineering firm Control Point on Wednesday. The purchase is likely to be central to the growth of Ricardo’s defence business and will significantly expand the range of opportunities which can be pursued within the US defence sector.

While positive for the company’s outlook, it continues to lack investment appeal given its current valuation. Ricardo trades on a P/E ratio of 13.8, and yet is expected to increase its bottom line by just 5% next year. This means it has a PEG ratio approaching three, which suggests there may be better opportunities available elsewhere. Certainly, it is making progress as a business, but from an investment perspective it lacks a sufficiently wide margin of safety to merit purchase.

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Peter Stephens 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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