With the FTSE 100 having made major gains in recent years, it is perhaps unsurprising for there to be a number of overvalued shares in the index. After all, investor sentiment has been optimistic and a bull market usually means that the valuations of some shares become difficult to justify.
One example of an overpriced company appears to be estate agency Purplebricks (LSE: PURP). While the business is making progress in executing its strategy and it could offer growth potential in the long run, the valuation multiple being applied to the stock seems to be excessive. As such, now could be a good time to sell it in favour of this FTSE 100 growth stock.
Clearly, Purplebricks has a bright future. The market is expecting it to move from a loss in the current financial year to a profit next year. This has the potential to improve investor sentiment after what has been a relatively long road to profitability. A black bottom line could show uncertain investors that the company has a viable business model which is able to generate positive earnings as well as the impressive levels of market share and revenue which have been delivered in the past.
However, the problem facing investors is that the stock price appears to now fully factor-in its future prospects. In other words, while Purplebricks may enjoy further business success, from an investment standpoint it seems to lack appeal.
For example, it trades on a forward price-to-earnings (P/E) ratio of 224. Even when its forecast rise in earnings for the 2020 financial year is factored-in, it still has a rating of around 28. This suggests that the market is expecting strong financial performance and even if it is delivered as expected, there seems to be limited upside potential on offer over the next couple of years.
In contrast, FTSE 100 company ITV (LSE: ITV) appears to offer a wide margin of safety. The business has experienced some difficulties due in part to the impact of Brexit. As a cyclical company, it has been hurt by the reduced confidence of businesses given the challenging prospects faced by the UK. Evidence of this can be seen in its earnings decline of 6% in the last financial year.
However, with a new management team and a refreshed strategy, ITV appears to have a bright future. Its strategy has been successful in recent years, with the company now having an increasingly diverse offering. And with the prospects for a Brexit deal seemingly improving, the UK’s economic performance could surprise on the upside over the coming years.
Since the stock trades on a P/E ratio of around 9, it seems to offer excellent value for money. Therefore, it may be worth selling highly-rated stocks such as Purplebricks in order to take advantage of potential bargains in the FTSE 100.
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Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has recommended ITV. 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.