Is ASOS plc The Most Overvalued Company In The Stock Market?

ASOSThere are as many types of shares are there are types of companies. Some shares are oversold, and beaten down, yet with strong fundamentals – what we call value shares. Then there are shares of companies that are rapidly growing revenues and earnings – growth shares. Some shares seem to have grown as much as they are likely to grow, and tend to yo-yo within a trading range. Some types of share rise incredibly quickly, driven by a breathtaking pace of growth, pushing the price to levels that are scarcely believable. These are momentum shares.

You may only discover one momentum share in your whole investing career. But if you spot such a company early, invest well, and then wait patiently, just one share like this can make an investing career.

One of the success stories of internet retail

ASOS (LSE: ASC) was one such company. From the depths of the Credit Crunch in 2007, to early 2014, the company 500-bagged. ASOS is one of the success stories of internet retail, and this company came out of nowhere to be a multi-billion company that is now one of the UK’s leading online retailers.

At its share price peak, this upstart was worth nearly as much as retail giant Marks and Spencer. Yet Marks & Spencer has 20 times as many employees as ASOS, and is far more profitable.

But the trick with momentum investments like this is to take your profits as near to the peak as possible – and then don’t ever look back. Because when the share price falls, it really falls.

But growth is slowing

At the time it reached its peak, ASOS was clearly the most overvalued company in the stock market, with a P/E ratio of well over 100. Since then the share price has fallen further and further.

After falling so much, could the company be a contrarian buy? Well, as always, check the fundamentals first. Consensus estimates a 2014 P/E ratio of 46.8, and a 2015 P/E ratio of 46.2. The business does not pay a dividend.

These numbers tell me that ASOS’s growth seems to be slowing. And yet the P/E ratio is still one of the highest in the stock market. Remarkably, despite the precipitous fall in the value of the company, it is still one of the most overvalued businesses in the stock market.

And although there is less growth, there is no dividend being paid at all.

I think ASOS is an impressive firm, an example of British creativity and innovation, and it may well have a second burst of growth as it invests to expand internationally. And it also happens to be one of my wife’s favourite clothing companies. But, as an investment, I would steer well clear.

Where we think the smart money is headed

When markets are rising, investing seems easy. It's when markets fall that people realise how difficult investing really is. It is at these times that people look much more closely at valuation and the inherent strength of a company.

We at the Fool think that these fundamentals will be crucial in investing over the next few years. We have written a free report which explains our view.

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Prabhat Sakya has no position in any shares mentioned. The Motley Fool UK owns shares of ASOS. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.