Even the best businesses can become overvalued, based on the particular value parameters you work to. In such situations, you can either keep raising your valuation threshold as the market rates the stock more highly — and thus continue to hold or even buy more — or stick to your valuation discipline and sell.
I favour the latter. Here’s why I’d sell two FTSE 100 stocks on valuation grounds at their current levels.
Housebuilder Berkeley (LSE: BKG) was founded in 1976 and is a company I admire for its prudent progress under its highly experienced management team led by founder and chairman Tony Pidgley.
Berkeley has delivered fantastic share price gains and sackfuls of dividends since the financial crisis. However, this is a notoriously cyclical industry and while the company trades on an undemanding price-to-earnings (P/E) ratio, this is common before a downturn. As is its current top-of-the-cycle operating margin in the high 20s and price-to-book (P/B) ratio in the 2.5 region.
At a recent share price high of 4,000p, Berkeley’s P/B was 2.6, which compares with a peak P/B of 2.7 in 2007. Then, as now, the company saw a number of uncertainties and risks in the market but had a strong balance sheet and expected to be a resilient performer. However, business resilience and share price resilience are two different things. Berkeley’s shares lost over two-thirds of their value from peak to trough between summer 2007 and summer 2008.
The company’s focus on London and this week’s rise in interest rates add to my concern about the current valuation.
Follow the money
Finally, Berkeley’s shrewd boss Mr Pidgley has, as the Daily Telegraph wrote in 2009, “gained a reputation for calling property cycles correctly — liquidating assets ahead of the late 1980s housing crash, shifting resources into the blossoming city centre market in the 1990s, and pulling back from volume housebuilding in 2004.”
This year, he’s been selling Berkeley shares with a vengeance: £31.1m in April, £26.8m in September and £28.9m last month. Other director sales include the chief executive and his wife for a combined £37.1m.
In vogue but not with me
Fashion house Burberry (LSE: BRBY) is a company I admire for the strength, longevity and global appeal of its brand. Indeed, it possesses qualities Warren Buffett looks for in a business. My rationale for rating it a ‘sell’ is rather more straightforward than for Berkeley.
I believe Burberry’s 12-month forward P/E of over 22, at a current all-time high share price of a bit over 1,900p, is simply too expensive. Forecast earnings growth of 9% over the period gives a price-to-earnings growth (PEG) ratio of 2.4, which is significantly above the PEG ‘fair value’ marker of one. A low 2.3% dividend yield also points to overvaluation in my book.
I believe Burberry’s shares offer great long-term value when trading on a forward P/E in the teens, as they have not infrequently in the past. However, as it is, I see more attractively valued stocks in the market today and reckon it likely Burberry will be available on a cheaper rating at some point in the future.
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G A Chester has no position in any of the shares mentioned. The Motley Fool UK has recommended Burberry. 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.