At the end of last year, the CEO of Smith & Nephew (LSE: SN), one of the UK’s leading medical technology companies, suddenly stepped down after only 18 months at the helm.
Namal Nawana reportedly quit because the company could not meet his pay demands. He had previously worked at US diagnostics business Alere, where he was paid $8.6m in 2016. At Smith & Nephew, his package was just $1.5m.
Unfortunately for the company’s shareholders, Nawana seemed to be making a lot of progress at the organisation. Earnings per share were expected to increase by 12% this year. The stock rose 30% between his appointment and departure.
The market is now expecting quite a lot from the business. The stock is trading at a price-to-earnings (P/E) ratio of 22, compared to the market average of just 13. These figures suggest if the company doesn’t meet growth forecasts for the year, the share price could suffer. A return to the market average multiple could leave investors nursing losses of more than 40%.
Unfortunately, it’s quite likely Smith & Nephew will miss these targets. Sudden management changes at any business usually result in disruption. Costs can increase and projects can be delayed. As Nawana had only just started to make an impact when he left, the disruption is likely to be even bigger.
As such, it might be worth avoiding Smith & Nephew in 2020. Its high price, coupled with the risk to growth from the CEO’s departure, suggests the risk-reward ratio of owning the business isn’t attractive.
Another FTSE 100 stock that might be worth avoiding in 2020 is the global gaming group Flutter Entertainment (LSE: FLTR). Formerly Paddy Power Betfair, Flutter’s earnings have expanded rapidly over the past six years. Sales have nearly tripled since 2013, and net profit has doubled.
However, as the number of shares in issue has doubled since 2013, earnings per share haven’t budged despite the group’s explosive growth during the past six years.
Nevertheless, despite this setback, investors have been happy to bid the stock up to a premium multiple. The stock is currently dealing at a P/E ratio of 26, which means it’s more than twice the price of the rest of the market.
This valuation doesn’t leave much room for error. Analysts are expecting the group to report a slight decline in earnings this year, which the market seems to have taken in its stride. But if the company misses this growth projection, the stock could lurch lower. Just like Smith & Nephew, a return to the market average multiple could push shares in Flutter down by more than 50% from current levels.
The chances of this happening are high. Flutter has been spending big bucks to expand its presence in the US market since sports gambling was effectively legalised two years ago. It isn’t the only company rushing across the pond to take advantage of the opportunity. Competition is fierce, and there’s no guarantee Flutter will come out on top.
Therefore, it seems there’s a genuine risk the company will miss growth expectations in 2020. If it does, shareholders could be left nursing significant losses.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK owns shares of Paddy Power Betfair. 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.