It can sometimes be tricky evaluating a company whose share price has soared to new heights on the back of rapid growth. As businesses get larger it can become increasingly difficult for them to continue expanding at the same blistering pace as they did during their infancy.
Great expectations
High growth companies more often than not also come with a hefty price tag. Online fashion retailer ASOSÂ is a prime example, with its P/E ratio ranging between 64 and 95 over the last four years. This in itself is enough to put off many investors, particularly those seeking value. Another reason why many investors steer clear of companies with high P/E ratios is, of course, risk.
Growth stocks generally command premium P/E ratings to reflect the expectation of high levels of future growth. But when those high expectations fail to materialise the consequences can be devastating. This was the case with ASOS, the darling of the junior AIM market, when the shares crashed by 73% between February and October 2014. As I always like to say — the greater the expectation, the bigger the disappointment.
Fashion secret
This brings me nicely to one of ASOS’s AIM-listed peers in the online fashion world, Boohoo.com (LSE: BOO). The company has quickly evolved from being the UK’s best kept fashion secret to one of the leading global online fashion retailers.
In its most recent trading update, the Manchester-based firm said that it now expects revenue growth for FY2017 to be around 50%, ahead of the previously guided range of 46% to 48%. And with final results due next month, many investors will be wondering whether this could be an opportune moment to buy the shares before the official figures are announced.
City analysts are expecting the group to report a 90% increase in underlying earnings for the full year, which if achieved would still leave the P/E ratio at a sky-high 77. After a 277% share price gain over the past year I think that the market’s high expectations are already in the price, and the shares are simply too expensive to buy at current levels. I would rate Boohoo as a hold.
Favourable trends
Another fashion retailer reporting next month is JD Sports (LSE: JD). The FTSE 250-listed sportswear group is also expecting full-year results to be ahead of expectations, as strong like-for-like sales growth from the first half of the year continued through the second half.
No doubt the Lancashire-based retailer has benefitted from the favourable trends for athletic-inspired clothing and footwear, not just in the UK but throughout Europe. And although trends can change very quickly, I think the group’s continued investment in visual merchandising and creative marketing should continue to make it an attractive outlet for many brands.
With the shares trading at 19 times earnings for the current year, and dropping to a more modest 17 times by 2018/19, I see JD Sports as a far more attractive investment than Boohoo.com at the present time. Still a buy for me.