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Should you jump on the bandwagon with this rising share price?

Some investors like to chase momentum stocks – a share price that is rising. There can be few, if any, shares right now that can rival serviced offices group IWG (LSE: IWG), formerly called Regus. Its share price is up 71% over the past year and the gains have been particularly strong recently.

The story behind the gains

I think a lot of the gains are due to what might be termed the ‘WeWork factor’. Although WeWork is heavily loss-making it’s expected to very shortly launch a mega IPO in the US. I think the stretched valuations in the commercial property sector have pushed IWG up because it has a similar business model to WeWork. Divesting its business in Japan while adding other locations globally has also I believe played a role in exciting investors about the future prospects for the group. 

The numbers

The share price has been so steep that the P/E has been lifted to a very high 35. For a company that in its 2019 interim results posted anaemic operating profit growth, I think this is a worry. Operating profit including joint ventures rose by £200,000, or 0.4%, in H1 2019 versus the same period the previous year. Compare that to revenue growth of 12.3% and the question is why is profit growth so poor?

Part of the answer lies in overheads, which grew by 10% to £145.4m. And another part of the problem will be down to larger structural changes in the industry – more working from home, more demand for flexibility in renting offices because of WeWork’s business model.

What does it mean for investors?

I worry for a company with a P/E as high as IWG’s that cannot grow profits. Between 2017 and 2018 operating profits fell 8%. I think there is a mismatch between the rising share price and a poorly performing business and I’d avoid the shares in IWG despite the rising share price. Although the commercial property group has a lot of features for investors that make it preferable to WeWork, I still wouldn’t rate it as a very good investment opportunity. 

A better property choice?

The valuations of housebuilders are moving in the opposite direction to IWG’s. Fears around Brexit and the economy, as well as the end of Help to Buy, are pushing down the P/E ratios of all the housebuilders. Bellway (LSE: BWY) is well-positioned I think to reward shareholders. The P/E is under seven and the dividend yield is around 5%. This puts the company on a price-to-earnings-growth ratio of around 0.5 which indicates big potential for growth.

The dividend, despite the generous yield, is well covered by earnings so should be easy to sustain without the need for a cut, even if economic conditions do worsen. The dividend has also been growing strongly year-on-year and is continuing to rise. This is good news for shareholders and reflects the confidence of management in the prospects for the business.

Bellway recently announced that full-year pre-tax profit is expected to be in line with current market expectations as it built a record number of new homes. Sure, there was a note of caution, as is customary at the moment from housebuilders, about margins and the possibility of a decline in buyer confidence. But I’d say the business is performing well. This is proven by the average selling price ticking up 2.5% to £292,000.

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Andy Ross as 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.