In what was a very brief update, Purplebricks (LSE: PURP) confirmed on Monday that it is on track to meet expectations for the full year. This could potentially help to keep investor sentiment at high levels, with the company’s share price having gained 4% in the aftermath of the release.
However, this puts the stock on a forward price-to-earnings (P/E) ratio of 170. Given the challenges which the UK housing market faces, could the company be too highly rated to buy at the present time? Or could it be worth an even higher valuation over the medium term?
Valuing a stock such as Purplebricks is relatively difficult. It is currently a lossmaking business and since it is relatively immature, its financial performance is expected to improve dramatically in a relatively short space of time. For example, it is expected to move from a loss of £11m on a pre-tax basis in the current year, to a pre-tax profit of £9m next year. As such, its valuation must take into account potential future growth, as well as its near-term performance.
On the growth front, the company seems to be performing well. Even in tough conditions in the UK it continues to have a strong position within the hybrid estate agency sphere, while expansion abroad could prove to be a shrewd move. It may help the company to diversify ahead of the potential risks from Brexit and will mean it is less reliant on a slowing UK property market for future growth.
Clearly, expanding rapidly into new markets comes with risk. Purplebricks is seeking to diversify internationally before it has delivered a profit, and this may mean its financial standing comes under a degree of pressure. It also means that its capital may be stretched, with there being the potential for it to lose focus on what remains its key market.
Falling property prices and lower activity levels have hurt sector peer Foxtons (LSE: FOXT). The London-focused estate agency recorded a fall in its bottom line of 54% last year, with a further 52% decline expected this year. It now trades on a P/E ratio of 27, but as an established company its growth potential may not be particularly impressive. As such, it appears to be worth avoiding at the present time.
Looking ahead, the prospects for the UK housing market seem highly uncertain. The recent interest rate rise showed that inflation is being taken seriously by the Bank of England. Should it rise further then more interest rate rises could be ahead. This may cause the affordability of property to decline – especially among first-time buyers. Housing activity levels may fall even further and leave Purplebricks and Foxtons with a difficult outlook.
However, with growth potential both inside and outside the UK as well as a sound business model, Purplebricks could be worth buying for the long term. While somewhat risky, the potential rewards from investing in it could be exceptionally high.
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Peter Stephens 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.