Forget Tesla! I think the valuations of these FTSE stocks are also bonkers!

G A Chester explains why he’d avoid these three London-listed stocks, including a popular FTSE 100 pick.

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Value investing has fallen out of fashion in recent years. Markets have been driven higher by stocks whose prices have become detached from both reality and fundamental value. Concept stock Tesla is a prime example.

One arch-bull reckons Tesla’s share price could hit $7,000 within the next five years. In contrast, fundamentals-focused bears argue the stock is already grossly overvalued at $900. Some suggest it’s the best shorting opportunity in a generation.

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As a value investor at heart, I certainly wouldn’t touch Tesla with a bargepole. And there are some UK stocks I’d similarly avoid. Here are three.

Bonkers

Baillie Gifford, which manages FTSE 100-listed Scottish Mortgage Investment Trust (LSE: SMT), owns 7.5% of Tesla. It’s the second-largest shareholder after Tesla founder Elon Musk. Scottish Mortgage also counts the likes of biotech firm Illumina, streaming platform Netflix, and Chinese e-commerce group Alibaba among its largest holdings.

Many of the stocks trade at bonkers valuations, according to the principles of classic Benjamin Graham/Warren Buffett-style value investing. However, owning such stocks has paid off big-time for Scottish Mortgage. Its shareholders have enjoyed a return of 602% over the last 10 years.

At a current price of 652.5p, Scottish Mortgage’s shares are at a 2% premium to net asset value (NAV). The NAV is detached from reality and fundamental value, in my view. And with the shares trading at a premium, I see little margin of safety and considerable downside risk for buyers today.

Nosebleed

I’ve previously expressed my scepticism about the prospects of FTSE AIM-listed IQE (LSE: IQE). This self-styled “leading global supplier” of epi-wafers to the semiconductor industry is valued at £458m at a current share price of 57.5p.

Over two decades, IQE has gone through periods of high investment and heavily negative free cash flow (FCF). However, no real step-change in earnings and FCF has subsequently materialised. Indeed, when the company releases its 2019 results next month, things will have gone backwards.

Management has warned of an operating loss, and year-end net debt of between £15m and £20m, compared with net cash of £21m at the start of the year. Meanwhile, the company is valued at over three times management’s mid-point revenue guidance of £150m. And, looking ahead, at over 100 times analysts’ earnings forecasts for 2020. I’m getting a nosebleed just thinking about how high the valuation is.

Jam tomorrow

Fellow AIM-listed stock Versarien (LSE: VRS) – valued at £79m at a current share price of 51p – is another on my avoid list. Founded in 2013, the company has made six acquisitions.

Three of these (acquired for a total of £4.2m) were generating combined revenue of £11.7m in the year prior to their acquisition. For its latest financial year, Versarien reported total group revenue of £9.1m. As such, I’d find it hard to value the three revenue-generating businesses at much above the £4.2m Versarien paid for them.

This would leave £75m of Versarien’s market value attributable to the three non-revenue-generating acquisitions: 2-DTech (acquired for £0.4m), Cambridge Graphene (£0.2m), and Gnanomat (£2.6m). Commercial deals for these businesses’ products have proved persistently elusive, and I just don’t see how they can be worth anywhere near £75m. The promise of jam tomorrow is growing stale, in my view.

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G A Chester has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Netflix and Tesla. The Motley Fool UK owns shares of Alibaba Group Holding Ltd. 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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