Precious metals miner Fresnillo (LSE: FRES) is one of the most popular stocks in the FTSE 100. Indeed, at the time of writing, shares in this business are dealing at a forward P/E of 33.3, compared to the market average of just 13.3. This makes Fresnillo one of the top five most highly valued companies in the UK’s leading blue-chip index.
And it’s for this reason I’d avoid the company at all costs. Fresnillo isn’t a bad business — last year it reported an operating profit margin of 24% — but, in my opinion, paying such a high price for this stock is bound to end in disaster.
The shares could fall by 50% before even coming close to the rest of the gold mining sector’s valuation.
If you want exposure to the price of gold, there are many other assets you can use in place of this highly-valued enterprise, not least gold itself. A dividend yield of 1.5% does sweeten the appeal but, in my mind, this isn’t enough to make up for the premium valuation.
Another business I would avoid it all costs is Pearson (LSE: PSON). It calls itself a “learning company” because it produces a range of educational products for sale around the world. This is a highly competitive market, and while the enterprise might have size on its side, the fact net income has hardly grown over the past six years speaks volumes.
Analysts are forecasting an 8% decline in earnings per share for this year, followed by a small rebound of 5% in 2020. Even after this growth, Pearson will still be earning less than it was in 2013, according to City figures.
At the time of writing, shares in the business are dealing at a forward P/E 14.3. I think that’s too expensive for a company struggling to grow in a highly competitive market. A dividend yield of 2.4% does add something to the mix, but it’s not enough in my view to make up for the lack of growth here.
Another business I think is overvalued, considering its prospects, is water supplier Severn Trent (LSE: SVT). Ignoring the fact Labour leader Jeremy Corbyn has promised to nationalise utility companies if he becomes prime minister, shares in Severn Trent look like a bad investment for multiple reasons.
First of all, there’s the stock’s valuation. It’s dealing at a forward P/E of 15.6, nearly 20% above the market average, even though earnings are expected to decline 3% in its current financial year, and 14% the year after.
Further, the company has a tremendous amount of debt, £6bn to be exact. Net gearing, the ratio of net debt to shareholder equity, is 520%, which makes the firm one of the most indebted in the FTSE 100.
Still, Severn does provide an attractive level of income with its 4.8% dividend yield. However, although considering all of the above, I do not think it is sensible to pay a premium for this level of income. There are other investments in the FTSE 100 that will give you more for your money.
Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended Fresnillo and Pearson. 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.