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Why I’d ditch plummeting plc for this fast-rising growth star

Over the past six months the share price of market darling (LSE: BOO) has plunged by 28%. That comes as investors have had time to digest management’s decision to prioritise revenue growth for new brands over margins as well as the sale of 4.6m shares by co-CEO Carol Kane following half-year results.

And while many investors may view this dip as a buying opportunity — for example, a full 12 of the 14 analysts covering the stock rate it a Buy or Outperform — I still view at as dangerously overpriced, at 61 times forward earnings. For a company that offers low barriers to entry and trades in a notoriously cyclical industry, such brands can fall out of favour just as quickly as they became a hit.

What started the recent sell-off in Boohoo’s shares was management’s guidance back in September for full-year EBITDA margins to fall to around 9-10%, below prior guidance and current period results. The reasons for lower margins was the group’s decision to invest in marketing for its newly- acquired brands, keep prices lower than competitors for the core Boohoo brand, and invest in expanding its distribution arm.

While it’s good to see management investing in the brand’s future, I worry that needing to aggressively keep the cost of its clothing low, while also diversifying into new brands, means we may be looking at a hard ceiling on the group’s profitability. After all, Boohoo primarily competes on price and there are myriad of competitors offering similar merchandise that have found selling £15 dresses online is fairly easy to do.  

This wouldn’t be a problem if it weren’t for the group’s eye-watering valuation. If management can’t substantially increase margins it will have to continue to grow revenue at an astronomical rate if it’s to ever grow into its valuation. And while management has thus far had little problem recording high levels of growth, that will naturally become harder as it grows in size. Furthermore, if investors begin to believe margins will be permanently low, it will only take one or two quarters of slowing top line growth for them to re-evaluate the hefty growth premium they have awarded Boohoo’s share price.

Slow but steady wins the race

A much more interesting growth share in my eyes is healthcare software provider Craneware (LSE: CRW). While the company isn’t cheap, at 41 times forward earnings, it offers investors deep barriers to entry, a proven track record of increasing revenue and margins over time, and a huge growth market in the form of a US healthcare industry desperate to trim costs.

Half-year results released this morning show the group’s growth is continuing at a good clip, with revenue up 16% year-on-year to $31.1m, and adjusted EBITDA up 18% to $9.7m. Thanks to highly-visible recurring revenue, we also have a very good picture of where the company’s going. Over the next three years, a full $179.4m of revenue is already contracted while the group’s order book is at record levels as it wins over new hospital groups and introduces new software to existing clients.

And there’s good scope for profits to continue rising ahead of sales as the benefits of scale roll in. While the company may be valued highly, I reckon these positives — and a huge net cash position — make Craneware one stock I’d own for the long term.

But 41 times forward earnings is still pricey, so bargain hunting investors may find this one Top Small Cap idea from the Motley Fool a more interesting idea trading as it is at just seven times earnings.

And despite this rock-bottom valuation, the group is growing nicely with earnings increasing by double-digits four years in a row.

To discover this under-the-radar value and growth stock, all you need to do is follow this link for your free, no obligation copy of the report.

Ian Pierce has no position in any of the shares mentioned. The Motley Fool UK has recommended and Craneware. 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.