Why I’d sell Versarien plc and this overpriced growth share

Shares in specialist touchscreen manufacturer Zytronic (LSE: ZYT) fell 2% in early trading this morning after posting results that were slightly ahead of market expectations, perhaps indicating that the shares are overpriced. 

I’ve closely followed the company for years now because the unique intellectual property that it has created since the late 1990s helps it earn outstanding returns. The company has averaged roughly 19% return on capital over the last five years, while operating margins last year peaked at a whopping 23.7%.

The group’s operational gearing meant that a 9% revenue increase in 2017 turned into a 27% jump in profit before tax. In all, it made £4.6m profit last year, leaving the shares on a P/E of 17.5. 

Low visibility warning

This might seem a bargain given that huge step forward in profits, but Zytronic hasn’t got the best visibility on sales and I believe it is possible it will experience a bad year that could significantly knock the share price. 

This happened back in 2013, where poor orders saw profits slide from £3.3m to £1.7m, sending the shares tumbling. While I believe it is a great business, the market has a short memory. I think investors would be best off waiting for one of these down years to purchase the shares. Those that got in at the bottom in 2013 are now up over 200% before dividends.

For truly long-term investors who are willing to weather some share price volatility, however, I believe now could be a good entry point. The company’s 3.7% yield is nicely covered by cash flow and should survive a bad year or two given the £14m cash on the balance sheet. 

There are certainly worse buys out there than Zytronic right now, but I’ll bide my time for a lower shower price before initiating a position. 

Patent-protected, profit-free

Shares in Versarien Technologies (LSE: VRS) shot up from 14.5p to 80p after releasing interim results in November. The company’s expertise in advanced materials with thermal management properties has clearly chimed with investors and customers alike, with revenues jumping 167% to £4.38m in the first half. 

Despite this progress, I wont be investing in the company for a few reasons. Firstly, I find it hard to tell whether its products are truly unique enough to deliver long-term, market-beating returns. I’m no scientist or engineer, after all, and many companies have struggled to turn a profit from graphene. Secondly, Versarien is not profitable, although it admittedly is taking solid steps towards break-even. Losses before tax halved in H1 to £0.77m. 

Given its rapid growth, I imagine the company will be profitable in a year or two. A successful placing in November has also raised £2.8m net of expenses, so the balance sheet looks secure for now. 

I believe that Versarien has a great shot at becoming a soundly profitable business, but it’s market cap is a massive £108m. That seems quite optimistic given its £1m cash burn in the first half.

I’m not in the business of making speculative investments and, in my opinion, the current valuation would have to come down considerably before I’d consider taking a position in the company. Perhaps I’ll be interested after the company publishes further details on the deal it has signed with two large consumer goods companies, but until then I’ll remain a little wary given the valuation.

A top growth share

If, like me, you're not interested in Zytronic or Versarien, perhaps our report A Top Growth Share From The Motley Fool, will be of interest. The company has been expanding fast while still achieving an impressive 18% return on capital. If everything aligns for this quality operation, our top analyst believes its value could increase four-fold!  To download the report, free of charge, click here

Zach Coffell has no positions 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.