Buying into the Fever-Tree Drinks (LSE: FEVR) share price at 163p in 2014, and selling in September 2018 for 3,863p, would’ve produced a not-insignificant 2,269% return on your investment.
Buying into Fever-Tree after the stock market crash at 935p a share and selling now would net you a cushy 156% return.
Fever-Tree, like many of its AIM-listed peers, rides the waves of stock market volatility. The current trend is upwards, so why realise that pleasing return now?
Fever-Tree is a growth stock slowing down
Quite simply, Fever-Tree Drinks is a growth stock slowing down. Historically, the impressive stock price performance reflects the market’s expectations for the carbonated mixers supplier.
Until 2019, the company’s revenues, profits, and assets were increasing year on year and the market loved it. But, growth stocks can’t climb forever at the same rate.
Indeed, in 2019, a 10% rise in revenues did not translate into growing profits as increased costs and reduced domestic sales took their toll. Despite a strong balance sheet, Fever-Tree wasn’t meeting analyst expectations, sharply depressing the share price, and slowing the growth curve.
Understandably, every investor wants above-average returns, and many will view growth stocks, like Fever-Tree, as a means of achieving this. But past growth is not an indicator of future growth and companies with good records usually sell at high prices.
An investor can be right about a firm’s prospects but also pay too much for a stock, lowering returns on their purchase.
Fever-Tree Drinks share price is expensive
Fever-Tree Drinks currently trades around 2,394p. Many share price websites will show a price-to-earnings (P/E) ratio for Fever-Tree, around 47. This ratio takes the current price of the share and divides it by 2019’s earnings per share (EPS) of 50.3p.
Usually, a lower ratio indicates better value for money. However, if the year in question was unusually profitable, it’s easy to overestimate a company’s proper value. Using a multi-year average reduces the odds of overestimating the true value of a company.
Over the last five years, Fever-Tree’s average EPS is 35.5p, giving a massive P/E of 67, against an industry average of 22. I think Fever-Tree Drinks is vastly overpriced, even before considering market conditions.
Fever-Tree faces market uncertainty
45% of Fever-Tree’s revenues come from ‘on-trade’ sales, meaning they arise from pubs and bars where alcohol can be sold to drink on-premises. It’s not yet clear what will happen to the pub trade in the short term due to the government’s coronavirus fears.
In addition, Fever-Tree’s artisan products, innovative at first, are now facing stiff competition from the likes of Cobell and other mixer manufacturers. Unless the firm can carve itself a new niche, it’s growth curve will flatten further.
Also thinking this way is fund manager Nick Train. His fund bought Fever-Tree for under 1,400p, not long after its sharp share price plunge earlier this year. He notes that the company needs to be “about more than tonic” and is eyeing stateside growth potential in ginger ale and soda water products.
There is a definite future for Fever-Tree; its solid balance sheet should sustain the company through short-term trouble.
However, its shares are too risky to buy at current prices. Upwards momentum for the stock makes it a good time to sell. I’d buy it again once the market adjusts. Just like Nick Train.
Rachael FitzGerald-Finch 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.