When assessing FTSE 250 stocks, I always look at valuation metrics to get an idea of a stock’s growth potential. One of the most popular such metrics is the price-to-earnings (P/E) ratio. It gives a quick idea of how the stock’s price stacks up against its recent earnings.
A good average is typically around 20, with anything below 15 suggesting potential undervaluation.
The problem is, it doesn’t always tell the full story. Popular growth stocks, particularly those in technology, can have P/E ratios in the hundreds — and still see their share prices climb!
So to get a more accurate idea of where things are headed, I always check earnings forecasts. With these, I can calculate the forward P/E ratio, comparing the price to expected earnings in the coming year.
I recently applied this approach to the respiratory equipment company Avon Technologies (LSE: AVON).
A closer look at Avon
Avon designs and manufactures advanced respiratory protection equipment used by military, law enforcement and fire personnel. Its products include the FM50 respirator, which recently secured a £10.2m order from the Ministry of Defence (MoD). This deal adds to an already strong order book, suggesting healthy cash flow over the next year.
The market has taken notice – the share price has surged 66.8% in the past 12 months. However, the valuation looks lofty at first glance, with a trailing P/E ratio of 127.2 and a price-to-book (P/B) ratio of 4.78.
On the surface, those numbers scream overvalued. But when we factor in forecast earnings growth, the picture changes. Analysts expect earnings per share (EPS) to rise from 67p to 86p by 2026 – a 30% increase. That gives Avon a much more palatable forward P/E ratio of around 30. Revenue is also projected to grow by 7% to £242.3m.
Importantly, full-year earnings have beaten expectations three years running. Plus, operating margins are set to climb from 9.7% to 12% in 2025 — another encouraging sign of efficiency gains.
That said, margins remain thin compared to some peers, meaning there’s less room for error. If sales momentum slows or production costs rise, profits could take a hit. Avon’s operating cash flow of £23.4m is also modest when set against total debt of £65.3m (although this is well-covered by equity).
Another factor to consider is Avon’s reliance on large government and military contracts. While lucrative, these can be delayed, scaled back, or cancelled due to budget changes or shifting geopolitical priorities. This concentration risk means results may be more volatile than those of more diversified manufacturers.
A promising investment
To me, Avon looks less overvalued than its trailing P/E suggests. The healthy forward outlook is backed by a robust order book and proven execution, as shown by repeated earnings beats.
There are still risks, notably its relatively thin margins and exposure to government budgets. But the growth forecasts and rising operating efficiency suggest a business moving in the right direction.
For investors seeking indirect exposure to the defence sector without buying a traditional arms manufacturer, Avon Technologies is a promising candidate to consider.
