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Should I buy shares in Sophos Group?

Since flotation in 2015, shares in cloud-based internet security specialist Sophos Group (LSE: SOPH) have gained 60%, while the FTSE 100 has managed 7%.

That’s a good result, but it hides a very volatile ride along the way. After really going nowhere for a couple of years, the shares took off in early 2017, and less than a year later were trading at three times their flotation price.

Sophos had all the hallmarks of a bandwagon stock, which growth investors jump on and buy purely because it’s going up, and the inevitable happened. The shares went into a slide, and even though 2019 has so far seen another bullish rise, those who were unfortunate enough to buy in at the peak are still sitting on a 40% loss in a little over 18 months.

Hot growth stock

To say the P/E valuation of Sophos shares became overheated seems like an understatement, with that multiple reaching around 170 in 2018. That was just before earnings per share more than trebled in 2019, mind, and the combined effect of that rise along with the share price fall has dropped today’s forward P/E to 34.

To me, that’s still a demanding growth valuation, and right now there isn’t too much short-term growth on the cards, with analysts forecasting a small EPS drop this year followed by an 18% rise next.

First-quarter revenue rose by a modest 3%, with billings up 5%. Adjusted operating profit gained 10%, and Sophos recorded impressive cash flow of $54.4m, so business is moving reasonably well.

But it seems to me that Sophos shares soared on the buzzwords of ‘internet’, ‘cloud’ and ‘security’. And while there is a growing market in that business and Sophos undoubtedly offers top-line services, I can’t help thinking the shares need a further downrating to make their valuation attractive.

Another growth bubble?

I’ve been meaning to examine AJ Bell (LSE: AJB) ever since the investment platform provider made its market debut in December. I’m a regular user of the company’s Dividend Dashboard, which is released quarterly and examines the overall dividend picture painted by FTSE 100 forecasts, but I hadn’t delved deeper.

One of my investment rules is to never buy at flotation, mainly because they’re priced and timed to try to raise the most cash for a company’s private owners rather than to provide punters with a bargain opportunity. In following that rule, I’ve missed out on the 70% rise that less cautious investors have enjoyed. But what I ask myself now is whether that’s just more ‘new growth stock’ over-enthusiasm that will soon fall back, or whether it represents a rational and sustainable valuation.

Growth

AJ Bell’s Q3 update reported a 5% rise in customer numbers, and a 13% jump in assets under administration over the past year to push the total above the £50bn mark, at £50.7bn. I’m pleased to read that net inflows of £1bn suggest that investors are taking advantage of the Footsie’s current turmoil, and they benefited from £1.6bn in favourable market movements.

The big problem is that, though forecasts are a bit thin on the ground at this stage in AJ Bell’s life as a public company, what we do have suggests forward P/E multiples in the 60s. There’s surely room for growth, but I see this as another overheated valuation and I expect the bubble to burst.

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Alan Oscroft has no position in any of the 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.