2 high-growth stocks you might regret buying

These two spectacular growth stocks look too highly valued, says G A Chester.

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Ocado (LSE: OCDO) released its annual results today and also announced a placing of 31.5m shares (in process as I’m writing), which I reckon could raise up to £150m. At a current share price of 470p the FTSE 250 online grocer has a market capitalisation of £3bn and continues to be something of an enigma for investors.

Pricey grocer

Today’s results show revenue of £1.5bn for its latest financial year (53 weeks ended 3 December), which was 15.2% ahead of the prior 52-week year, or 12.7% on an adjusted basis. Pre-tax profit for the year was £1m.

To put these numbers into one context, Tesco, in its last financial year, delivered 38 times Ocado’s revenue and 145 times its pre-tax profit. Yet the FTSE 100 firm’s market cap is little more than five times bigger. Sure, Ocado has more scope to increase its share of the UK grocery market, but not that much more. And certainly not enough to merit a forward price-to-earnings (P/E) ratio of 330.

More than yams and cans in vans

However, Ocado isn’t simply a business that delivers groceries in vans. It’s built a whole technological and physical ecosystem, which includes digital commerce platforms and robot-operated warehouses. After a number of years of touting its end-to-end solution to international retailers — and repeated promises a first deal was imminent — 2017 was the year it finally happened. It inked an agreement with an unnamed regional European retailer in the summer. And it’s since announced a second deal with France’s Groupe Casino and a third with Sobeys in Canada.

Ocado has always had supportive institutional investors, who have bought into its ambitious, long-term vision but also a fair number of hedge funds, who have backed against it. Currently, there are eight declared positions, which together have sold short 10% of the company’s stock.

The shares have almost doubled in little more than two months. The company is confident of inking more international deals but I think it will need a good few even to justify the current price. As such, I think the valuation is overly high at this point, so it’s a stock I’m avoiding for the time being.

Hot stock in hot sector

Another FTSE 250 stock I’m avoiding on the basis of a super-high valuation is cybersecurity group Sophos (LSE: SOPH). The company describes itself as “a leading global provider of cloud-enabled end-user and network security solutions, offering organisations end-to-end protection against known and unknown IT security threats through products that are easy to install, configure, update and maintain.”

Obviously, cybersecurity is a market where there is strong demand and Sophos is seeing good momentum in its business. However, I believe investors have fallen head-over-heels in love with this ‘hot’ sector and driven Sophos’s shares up to an over-elevated level. They’ve soared from an IPO price of 225p in 2015 to around 600p today, valuing the business at £2.8bn.

According to Reuters, analysts are forecasting earnings per share of $0.07 (5p at current exchange rates) for the company’s financial year ending 31 March, followed by $0.11 (7.9p) for fiscal 2019. This gives P/E ratios of 120 and 76. I don’t see much wrong with the business but the current valuation simply looks too high to my eye.

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G A Chester has no position in any of the 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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