Finding shares that could outperform the FTSE 100 is never a straightforward task. Certainly, unearthing businesses with bright futures is possible for even the most time-poor investor. However, in many cases much of the growth potential of a business has already been priced-in by the market. Reporting today is a stock which, while offering a strong track record of growth, seems to be overvalued at the present time.
The update released today by sales and marketing company DCC (LSE: DCC) shows that it made encouraging progress in its third quarter. Operating profit was ahead of the prior year and in line with expectations. In particular, DCC Energy benefitted from strong organic volume growth in LPG as well as sound organic growth in both Retail & Fuelcard and Oil. Similarly, DCC Healthcare overcame the headwind of weaker sterling and benefitted from an improved performance in DCC Health & Beauty Solutions.
Meanwhile, DCC Technology’s operating profit grew sharply versus the prior year and it benefitted from the CUC acquisition. DCC Environmental saw good organic growth, which made a positive contribution to the company’s overall performance. Looking ahead, the acquisition of Esso Retail Norway for a total consideration of £235m (also announced today) could generate a return on invested capital employed of around 15% in the first year.
However, DCC’s valuation appears to take into account its upbeat performance and its future prospects. In terms of the latter, its bottom line growth rate of 8% next year and 4% the year after represents a significant downward step from the double-digit gains recorded in recent years. Despite the lower profitability expected over the medium term, DCC continues to trade on a relatively high valuation. For example, it has a price-to-earnings (P/E) ratio of 22.8. This equates to a price-to-earnings growth (PEG) ratio of 3.8 when combined with its growth forecast.
Due to its high valuation, the company’s share price gains in 2017 may fail to match those of the FTSE 100. Certainly, DCC is performing well as a business and has a bright long-term future. But its valuation appears to be excessive, given its near-term profit growth forecasts.
A superior alternative?
Within the same sector is Capita (LSE: CPI). Clearly, it’s a far riskier stock to own than DCC, since it’s at the beginning of a major turnaround programme which may or may not lead to improved financial performance. In fact, in the short run it would be unsurprising for further disappointment in terms of its profitability, since the outsourcing industry is experiencing lacklustre growth at the present time. That’s a key reason why Capita’s bottom line is due to fall by 7% this year.
However, with growth in its earnings of 4% due to be reported next year, Capita could be a strong turnaround stock. Its P/E ratio of eight indicates there’s substantial upward re-rating potential, which may allow it to beat the FTSE 100 in 2017.
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Peter Stephens owns shares of Capita Group. 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.