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Why I’d sell Purplebricks Group plc to buy IQE plc

It’s no surprise that hybrid online-offline estate agent Purplebricks (LSE: PURP) has taken the market by storm since listing in late 2015 with its disruptive business model, highly ambitious founder-led management team, and rapid expansion. But with the company’s market cap now up to a staggering £1.2bn I think now may be a good time for investors to reassess whether or not this is the time to buy its stock.

My main cause for concern is that with only £46.7m in revenue for the financial year to April, the valuation has already priced in several years of stellar growth. While the company could meet or exceed market expectations, this is always a dangerous game for retail investors to play as the stock price could fall dramatically were the company to report even a quarter or two of lower-than-expected growth.

And while its UK operations are now profitable, the group still recorded £6m in pre-tax losses overall last year due to lack of scale in Australia and the US and increased marketing spend as it pushes into these two markets. This situation is unlikely to change anytime soon as low brand penetration in these markets will require the same heavy investments that the company undertook in the UK in past years.

This isn’t to say management is wrong to expand as quickly as possible since its business model is readily mimicked and its first mover status is its only real competitive advantage. With £71.3m in cash on hand at year-end due to a recent rights issue, it shouldn’t run into problems funding this expansion for the time being.

But with a valuation that appears quite stretched I’d have a hard time justifying beginning a stake in Purplebricks right now. And, if I were a current shareholder I’d take a close look to see whether or not the company makes up an outsized part of my portfolio following its recent share price run up.  

The UK’s new tech champion?

I’d be much more likely to take a stake in IQE (LSE: IQE), which makes compound wafers for semiconductors. I prefer the company to Purplebricks because it is already profitable.And it has a much deeper competitive advantage with a market-leading position in key sectors, products that are based on its own patented intellectual property, and a customer base of well-known semiconductor manufacturers that are predisposed to stick with proven suppliers for many years.

The company’s outlook is also bright as its burgeoning photonics division takes off due to advances in laser technology and optical sensors that are being used in a wide range of industrial and consumer technologies, ranging from healthcare to smartphones and data centres.

In the half year to June double-digit growth from the photonics division contributed to a 16% year-on-year increase in wafer revenue and led group revenue for the period to rise to £70m. Growth looks set to ramp up in the coming quarters as management invests in expanding production facilities in preparation for mass market demand for its photonics devices.

With the company’s shares pricey at 34 times forward earnings there’s little room for error and I’d do my homework before investing, but I like the company’s wide moat to entry for competitors, rising margins, healthy balance sheet and enviable growth prospects.

If you prefer your growth shares to come with a more reasonable valuation I recommend checking out the Motley Fool’s Top Growth Share of 2017, which trades at under 20 times earnings despite its share price rising over 150% in just the past five years.

To discover why the Fool’s Head of Investing reckons this founder-led company’s stock could triple in the coming decade, simply follow this link for your free, no obligation copy of his report.

Ian Pierce has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.