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Why I’d be wary of this FTSE 250 performer and what I’d buy instead

With its market capitalisation around £5.5bn, Aveva Group (LSE: AVV) is the second-largest firm in the FTSE 250. The company deals in software for engineering, design and information management and its rise to the upper echelons of the index reflects in the astounding progress the share price has made over the past few years.

An impressive share-price climb

The move is interesting. Ten years ago, the share price stood close to 400p and then advanced around 200% over the following eight years. But then it accelerated, moving more than 170% higher in the past two years alone to give shareholders from 2009 a capital gain in excess of 750% — the majority of which occurred in the last two years of a 10-year holding period.

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Indeed, Aveva’s historical share-price action is a good advertisement for buy-and-hold investing. However, the fundamental reasons driving the move are less clear, and I’m cautious about shareholder prospects from here.

The five-year financial record shows revenue accelerating from 2018 onwards, powered by the 2018 combination of Aveva with the Schneider Electric industrial software business. That expansion has perhaps transformed the outlook for Aveva. But profits and cash flow lag and, so far, fail to justify the racy forward-looking earnings multiple of just under 35 that Aveva has for the trading year to March 2020.

In fact, over the past five years normalised earnings have been weak and City analysts following the firm are forecasting earnings will return this year to levels last seen around 2014. Meanwhile, operating cash flow has been patchy and is today back to where it was in 2013. There’s also a clear decline shown in the record for operating margin.

Trading well, but growth underwhelming

Today’s full-year results represent the first complete year of trading with the combined and enlarged company. Aveva has provided handy pro forma figures designed to show how well both parts of the business have been trading as if they were still separate businesses. On that basis, overall revenue increased by almost 12% compared to the year before, and adjusted diluted earnings per share moved 27% higher. The directors increased the final dividend for the year by 7.4%.

However, with the share price close to 3,468p, the dividend yield is running near just 1.3% and the payment is covered around twice by earnings. I think the low yield is another indication Aveva could be over-valued by its share price.

Chief executive Craig Hayman explained in today’s report that the company achieved “a strong performance in its first full year as a combined company.” Integration is going well and Hayman is “confident” in the outlook.

City analysts expect earnings to grow around 15% in the current year, a rate of progress that falls short of the firm’s current valuation, in my view.

I think the business is interesting and the stock is risky. This is one of those occasions where I’d rather invest in a low-cost, diversified index-tracking fund than in this individual share.

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Kevin Godbold has no position in any share 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.

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