The best performing stock in the UK’s leading blue-chip index, the FTSE 100, last year was online retailer Ocado (LSE: OCDO). Shares in the company added more than 100% in 2018 and jumped 50% in a single day back in May when it revealed a tie-up with US supermarket Kroger.
However, over the past three months, the shares have slumped 9.5%, and while this is a slightly better performance than the rest of the FTSE 100, I think it could be a sign of things to come.
A sign of things to come
One of the reasons I’ve always been wary of the shares is their valuation, which has never been particularly appealing to me.
City analysts are not expecting the company to report a profit for 2018 or 2019, so it is difficult to figure out how much the shares should be worth on earnings alone, although we can use historical figures.
In 2017 the company reported a profit of 0.4p per share implying the shares are currently trading at a historical P/E multiple of 2,025.
That being said, shares in Ocado have always been priced based on potential rather than actual earnings, which, as we have seen over the past 12 months, can result in significant gains when the company gets it right. But even Ocado itself has admitted that it will be some time before it realises profits from the significant deals struck with clients.
With this being the case, I think in the current market environment it could only be a matter of time before the shares crash back to earth. The market has been willing to give the business the benefit of the doubt over the past few years, but now volatility has returned, I believe investors will turn their backs on speculative stocks like this and instead put their money to work in defensive dividend-paying champions.
I may be wrong, but this is what has happened in previous bear markets. If this trend plays out in 2019, then shares in Ocado could fall off a cliff.
Another speculative stock I’m avoiding in 2019 is Vectura (LSE: VEC). I used to be a fan of this business but ran out of patience following a series of disappointing trading updates.
After merging with peer Skyepharma several years ago, Vectura has struggled to find its groove. Following the merger, losses ballooned from £5.9m in 2012 to £86m in 2017, although cash generation has remained strong, which has enabled the company to push ahead in developing its treatment pipeline.
Today, management has informed the market that its efforts to restructure the business over the past few years are starting to pay off. According to the update, the group now expects “revenue to be in line with, and EBITDA to be materially above, current market consensus expectations.” This is undoubtedly great news, but there is still a sizeable speculative element here.
The company’s future rests on the approval of a generic version of GlaxoSmithKline‘s blockbuster Advair Diskus, which it is in the process of developing with partner Hikma. Regulators have already turned down the first attempt to get this new product to market, and the partners face an uphill struggle to get it there.
With the shares changing hands at 17.5 times forward earnings, I think Vectura is overvalued considering its uncertain outlook.
Rupert Hargreaves owns no share mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended Hikma Pharmaceuticals. 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.