Before I continue, I should note that I think this company is a British champion. Over the past few decades, the group has helped develop a range of new technologies and specialist equipment, earning it a reputation as one of the country’s best businesses.
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However, as the stock has surged and profits have stagnated, the stock has become less appealing. Unfortunately, it does not look as if this will change anytime soon.
FTSE 100 company challenges
In some respects, I am attracted to Croda’s business model. It is a champion of the unexciting, manufacturing specialist goods such as lipids, a key component of vaccines. It has also tried to branch out into electric vehicle batteries, although management has now announced that it will be exiting this business.
Croda made a strategic misstep with batteries. The company discovered it could not compete with larger competitors, which can manufacture more for less.
The business has also recently decided to sell off its industrial division. When complete, the group will have transitioned to a pure-play chemicals company focused on consumer care and life sciences. These are defensive businesses where demand is expanding.
If this is the case, then why would I avoid the business? I am worried about the FTSE 100 company’s valuation and growth potential.
Over the past three years, Croda’s net profit has hardly budged. Nevertheless, its stock has moved steadily higher. As a result, the shares are currently trading at a forward price-to-earnings (P/E) multiple of 45.
This premium multiple suggests the market is expecting a lot from the enterprise. But there is no guarantee it will be able to meet these lofty expectations.
Croda needs to stay on its toes to remain competitive. That means investing in new technologies and fast-growing industries. This strategy comes with its own risks. There the investments that may not work out and could lead to write-offs.
Of course, I could be wrong. The company has a history of innovation and changing with the times. There is no guarantee it will fall behind. The market may continue to pay a high multiple for the shares if the enterprise can stay ahead of the competition.
Still, with risks in the global economy growing, I am planning to avoid richly-valued businesses. If the business disappoints, the shares could slump back to the sector average multiple. This is around 20-25. If this scenario materialises, shares in the business could drop significantly from current levels.
Considering this risk, I think there are plenty of other FTSE 100 companies I would rather own in my portfolio.