As the FTSE 100 (FTSEINDICES:^FTSE) flirts with all-time highs, the market is taking an increasingly positive view towards growth stocks.
Actually, around one fifth of the FTSE 100 is currently trading at a historic P/E of greater than 19.9, the FTSE’s historic average, and a valuation usually assigned to growth stocks. Specifically, ARM Holdings, Hargreaves Lansdown and Randgold Resources lead the pack with historic P/Es of 71, 31 and 26 respectively.
The question is, are these growth stocks set up to fall, just as they have done many times in the past?
The online revolution
Indeed, ASOS currently trades at a forward P/E of 73, a multiple usually assigned to a high growth company. However, ASOS’s earnings are only expected to expand 18% this year, putting the company on a PEG ratio of 4, which makes the company appear expensive compared to its projected growth rate.
As a quick comparison, BHP Billiton, one of the FTSE 100’s largest components, currently trades at a PEG ratio of 0.7 implying that growth investors would be better off to place their money with this mining behemoth than ASOS.
Some investors have already started to question ASOS’s valuation. The company’s shares have collapsed by more than 30% so far this year, amid comments from the company’s management that growth during 2014 would be slower than expected.
ASOS’s management are calling 2014 “a year of investment”, which some City analysts have viewed positively. Specifically, analysts believe that after a year of investment, ASOS will be well placed to grab a larger market share of the huge global online apparel market
Unfortunately, the market is impatient and until ASOS can post some really impressive growth numbers, required to sustain the company’s high valuation, it’s likely that the shares will continue to slide.
Hard to compare
It is hard to compare Ocado and ASOS because Ocado has been unable to turn a profit, unlike its larger peer. That said, City forecasts call for Ocado to post a profit next year, although a profit of only £16.5m is expected, putting the company on a forward P/E of 124.
The problem is, such a high valuation multiple leaves little room for error, and if Ocado were to make a mistake, miss forecasts or run into any trouble, then the company’s shares could quickly head back to earth.
The same can be said of AO World. Much of AO’s expected growth is already factored into the company’s share price and if it fails to meet targets, then it is likely that investors will rush for the exit.
As a quick comparison, ASOS trades at a similar valuation to AO in terms of sales but while ASOS is established across Europe and North America, AO’s valuation is dependent upon its successful expansion into Germany and Europe.
Actually, some analysts have commented that to sustain its current valuation, AO’s move into Germany is “make or break” with “little room for execution risk”. It would seem as if Ocado’s and AO’s investors are taking on a lot of risk for minimal reward.
Looking for opportunities
The trouble with companies like AO World, Asos and Ocado is the fact that they have already been discovered and as a result, investors are prepared to pay a premium for the shares.
But there are other opportunities out there. The key, when searching for growth stocks, is looking under the radar. You want to get on board while the company is still an unknown quantity.
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Rupert does not own any share mentioned within this article. The Motley Fool has recommended shares in ASOS.