With the FTSE 100 having risen to record levels this year, it’s unsurprising that the valuations of some stocks now seem excessive. After all, investor sentiment is currently very bullish and this could cause the stock market to overestimate the potential returns available. It may also mean that risk is being underestimated.
With that in mind, here’s one stock which seems to be overvalued and could be worth selling in order to buy oil producer Premier Oil (LSE: PMO).
Improving outlook
The seemingly overvalued company in question is global engineering and strategic, technical and environment consultancy business, Ricardo (LSE: RCDO). It reported impressive first half results on Wednesday which showed an order intake of £235m. This is £50m higher than in the same period of last year and represents an organic growth rate of over 25%. It was generated from a broad mix of sectors, including the development of electric vehicle battery systems from a customer in China.
The company’s order book has increased to a record high and was in excess of £290m at the end of December 2017. This compares to an order book of £244m at the same time last year. With net debt falling from £38m to £32m in the last six months, the company’s financial standing appears to be strong.
Looking ahead, Ricardo is expected to report a rise in its bottom line of 7% in the current year, followed by 5% next year. While it’s performing well and has a bright future, its valuation suggests that it may offer limited upside potential. Its shares have surged 480% higher in the last nine years and now trade on a price-to-earnings growth (PEG) ratio of 2.7. This indicates that now could be the right time to sell, rather than buy, the stock.
Growth potential
Of course, not all stocks are overvalued at the present time. As mentioned, Premier Oil continues to offer growth at a reasonable price. Certainly, the company is relatively high risk and lacks the size and scale of many of its sector peers. However, with a rising oil price acting as a tailwind, the business is expected to return to profitability in the current year. This is set to be followed by a rise in earnings of 41% next year, which could cause investor sentiment in the stock to improve.
Despite its upbeat financial outlook, Premier Oil continues to trade on a relatively low valuation. For example, it has a forecast price-to-earnings (P/E) ratio of around 6.5, which is expected to drop to just 4.5 next year, if its forecasts are met. This suggests that there is a wide margin of safety on offer, and this could make the stock’s risk/reward ratio highly favourable for the long run.
With the company having cut costs and restructured its business in the wake of the lower oil price, it now seems to be ready to deliver improving share price performance.
