Global music and audio products company Focusrite (LSE: TUNE) was a winning stock long before Covid-19 came along. In the three years to February, the share price rose around 250%. And the progress was powered by rising revenues and impressive double-digit annual increases in earnings.
Why Focusrite’s been a Covid-19-winning stock
The company’s offering has been resonating with customers. And Focusrite’s been a cash-generating growth stock through that period. But when the pandemic came along, sales rocketed even more, as today’s full-year results report underlines. Indeed, for the 12-months to 31 August, revenue shot up by almost 54% compared to the prior year. Adjusted diluted earnings per share also increased by just over 53%.
During the period, the firm was digesting its December 2019 acquisition of Martin Audio, which it paid just over £35m for. But it did so with ease, repaying the debt taken on to help fund the purchase within eight months. Such has been the strength of the company’s cash generation.
Company founder and executive chairman Phil Dudderidge said in the report the business benefitted from growth in demand for music and recording products. He reckons the surge in business occurred because professional and amateur musicians had to work at home or had more time to enjoy their “passion for music creation.”
On top of that, the use of Focusrite audio interfaces increased. He thinks that’s because more people have been podcasting and using Zoom and other platforms for creative applications in music. And there’s also been an uplift in film and TV dubbing and radio entertainment where actors voice productions from home.
The big question now for investors like me is, will customer demand continue at these elevated levels for Focusrite? And the answer from City analysts following the firm appears to be, no. Indeed, for the current trading year to August 2021, the consensus estimate for earnings suggests a decline of around 17% from the current elevated level.
The valuation could drag on the share’s progress
And the big problem for me is the valuation has rerated upwards by a considerable amount because of the company’s success. The share price is around 937p, as I write, which puts the forward-looking earnings multiple near 37.
But, in fairness, even though earnings will likely be lower than the 2020 figure, they’ll still be about 19% higher than those achieved in 2019. So Focusrite is still a growth proposition. But I wonder if the valuation now over-states the ongoing prospects of the business.
On balance, I’m cautious about Focusrite now and fear that the stock may struggle to make progress as the valuation potentially adjusts. Indeed, with Covid-19 vaccine-discovery announcements hitting the wires, I think big-winning coronavirus stocks could begin to struggle. Another stock I’m wary of right now, for example, is Covid-19 testing winner Novacyte.
Although both these businesses have ongoing potential, I reckon investors could endure a bumpy ride if the world begins to unwind from the coronavirus crisis. So, I’m inclined to watch these two from the sidelines now and look for promising investments elsewhere.
