Why I’d dump these 2 Neil Woodford stocks

G A Chester explains how he disagrees with Neil Woodford on the valuation and prospects of two popular stocks.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

After an eight-year bull run in equities, Neil Woodford has decided that now is the time to buy into “domestic cyclical companies where valuations are too low.” He does stress he’s buying “selectively”, rather than across the board. For example, he’s bought Lloyds but not Royal Bank of Scotland, Topps Tiles but not Carpetright and so on.

I agree that valuations of some of Woodford’s holdings look appealing but I think some sectors and picks are over-valued and risky at a time when, as octogenarian investor Lord Rothschild, said recently: “There could well be a period ahead of us when the avoidance of risk is as high a priority as the pursuit of gain.”

The areas and stocks that concern me are those in which I see asset valuations as particularly over-inflated by the distortions of the massive money printing experiment since the financial crisis, and whose fortunes are also linked to spending by consumers, whose debt loads are at unprecedented levels and who are now facing rising interest rates, a higher cost of living and low wage growth.

Materially overvalued?

Barratt Developments (LSE: BDEV) is one of a number of housebuilders Woodford has bought this year. It’s the 13th-largest holding in his flagship Equity Income fund and ranks at number six in his Income Focus fund.

Barratt’s operating margins and price-to-book (P/B) valuation aren’t as high as Berkeley’s, for example, but Barratt is a volume housebuilder and its high-teens margin and P/B of 1.8 at a share price of 620p are in cyclically high territory for this class of builder.

While forecast earnings per share (EPS) growth of 4.4% to 64p for the current year gives an undemanding price-to-earnings (P/E) ratio of 9.7, the price-to-earnings growth (PEG) ratio of 2.2 is well on the expensive side of the ‘fair value’ PEG marker of one. The cyclically high P/B and elevated PEG lead me to conclude that Barratt’s shares are materially overvalued.

With little fundamental reason, as things stand, for these ratios to increase much further — that’s to say by a rising share price — and increasing risk of a major housing market correction or crash, I rate the stock a ‘sell’.

Potential toxic brew?

BCA Marketplace (LSE: BCA), the UK’s leading used vehicle exchange, whose businesses include WeBuyAnyCar, is another Woodford holding, whose valuation looks stretched to me. Current-year forecast EPS is 10.6p, which at a share price of 191p gives a P/E of 18. A PEG of 1.2 isn’t altogether excessive but I believe earnings could start to come under pressure.

Car buying has been booming for a good number of years, fuelled by cheap consumer credit and financing deals. However, BCA has a skinny operating margin (3.7% last year) and the business is vulnerable to any fall in the volume and value of vehicles passing through its exchanges.

My foolish colleague Paul Summers has drawn attention to the cyclical nature of the industry and BCA’s rising debt. I’d add that net debt of £261m (up 53% on the previous year), excludes partner finance funding of £113m (up 75%) and finance leases of £31m. The company also bears risk in a falling market from its inventories of £58m (up 205%) and has negative net tangible assets. All of this could become a toxic brew in a downturn and I rate the stock a ‘sell’.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

G A Chester has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. 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.

More on Investing Articles

Investing Articles

3 of my top FTSE 250 stocks to consider buying before April

Buying undervalued UK shares can be a great way to generate long-term wealth. Here, Royston Wild reveals a handful on…

Read more »

Ice cube tray filled with ice cubes and three loose ice cubes against dark wood.
Investing Articles

Just released: our 3 top income-focused stocks to buy before April [PREMIUM PICKS]

Our goal here is to highlight some of our past recommendations that we think are of particular interest today, due…

Read more »

Investing Articles

Is this the best chance to buy cheap FTSE 100 shares in a generation?

I want to buy shares when they're cheap, and sell... never, just keep taking the dividends. And the FTSE 100…

Read more »

Man putting his card into an ATM machine while his son sits in a stroller beside him.
Investing Articles

Could NatWest shares be 2024’s number one buy for passive income?

For those of us looking to earn some long-term passive income, how does NatWest's 7% dividend yield sound? It sounds…

Read more »

Investing Articles

£12K in savings? Here’s how I could turn that into £13K annual passive income

This Fool explains how investing a lump sum can help her build a passive income stream to enjoy in her…

Read more »

Aerial shot showing an aircraft shadow flying over an idyllic beach
Investing Articles

Here’s why Rolls-Royce shares are now set to fly over the £4 mark

Once again, Rolls-Royce shares are crushing the FTSE 100. Should I add to my holding of this stock at the…

Read more »

Investing Articles

1 under the radar FTSE 100 AI stock investors should consider buying

Our writer explains why this FTSE 100 pick could be a shrewd investment with its established experience of using AI…

Read more »

Investing Articles

Does the beaten-down Diageo share price make it a no-brainer buy?

Harvey Jones spent years waiting for the Diageo share price to look like good value, before finally buying it in…

Read more »