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Will AO World PLC Go The Same Way As Ocado Group PLC?

AO World (LSE: AO), the online household appliances retailer formerly known as Appliances Online, was floated in February 2014 while not then yet a profitable company, and in its first year the share price soared as high as 336p. But since then it’s lost exactly half that value to 168p today.

In fact, as I write the price is down 8.3p (4.7%) on the day the company released full-year results headlined “AO World plc delivers significant growth and operational progress“. So what’s going wrong?

It’s happened before

AO reminds me of another recent flotation, Ocado (LSE: OCDO) — also selling essential household products — which followed a similar trajectory. People piled in and pushed the price up, and it took some time for investors to get their heads around how long it would take to turn a profit and value the shares accordingly.

After an erratic ride, the Ocado price is now up handsomely on its flotation price after posting its first profit in 2014, but its shares are still on a forward P/E of more than 160 for this year, falling only to 110 for 2016 — there’s nice growth forecast, but it will really need to be special to justify those ratings.

Targets missed

But back to AO World, which has just recorded a loss per share of 0.6p for the year ended March 2015. That was a big improvement over the 2.38p per share loss in 2014, in a year that looks pretty reasonable for a company in its early stages. Overall revenue rose by 24% to £477m, and the company claimed an adjusted EBITDA figure of £16.5m in its UK operations — in its early days, AO’s European operations are generating losses.

However, although these results look positive, they didn’t quite meet the firm’s targets for the year, with AO saying that “the current trading environment in the UK remains challenging“.

AO is expected to flip into profit this year, but only just, with around 4.6p EPS predicted for 2017 — putting the shares on a two-year-out P/E of nearly 40. That’s perhaps cheap relative to Ocado’s valuation, but with 2014 having fallen a bit short, there will be doubts about the current forecasts.

The growth conundrum

That beings us to the biggest problem with piling into sparkly new growth start-ups. For a while, everything comes in ahead of expectations and the price keeps soaring. But the punters expect things to beat expectations every time, and as soon as that stops happening there’s a rush for the exit. And it’s guaranteed that expectations-busting results will stop, sooner or later.

So what about AO World and Ocado? They’ll both achieve sustainable profits, I’m sure. But for me shares in both are way overpriced at this very risky stage.

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