Simple valuations such as the P/E ratio aren’t always much use for growth stocks. Successful, fast-growing companies trade on premium valuations because their expected future earnings are so much higher.
Today I’m looking at the latest results from two of this year’s top growth stocks. Should you buy, sell or hold these high-flyers?
Sweet music for shareholders
Shares of online musical equipment retailer Gear4music Holdings (LSE: G4M) have risen by 75% so far this year. The stock now trades on a 2017/18 forecast P/E of 79, so this week’s interim results needed to be near-perfect to justify further gains.
The good news is that the figures are very good indeed, in my opinion. Sales rose by 44% to £31.2m during the first half of the year, while gross profit was 36% higher at £7.8m.
Although the company’s gross profit margin fell by 1.6% to 25%, I think this is acceptable in a competitive market, as the group’s key performance indicators were strong. Average order value rose by 4.8%, while the conversion rate — the percentage of website visitors who make a purchase — increased by 0.46% to 2.84%. The total number of active customers was 44% higher, at 390,790.
I’d hold on for more
Gear4music’s first-half operating profit was pretty minimal though, at just £0.03m. But this could be a misleading figure. The group opened two new warehouses (in Sweden and Germany) during the period, incurring higher administrative costs.
It’s also worth remembering that the firm’s sales and profits are always heavily weighted to the second half of the year, which includes Christmas.
The Board remains confident of meeting full-year forecasts for revenue of about £81m, and net profit of around £2.1m. In my view, these shares remain a strong hold for growth investors.
An overlooked opportunity?
We all know that the video games industry is huge. But what’s often overlooked is the host of specialist technical services needed by games producers to ensure their products are a commercial success.
For example, games need to be adapted for sale in multiple countries and across multiple gaming platforms.
Keyword Studios (LSE: KWS) has spotted this opportunity and is building a significant presence in this sector. The group started out 20 years ago by providing spoken-word audio services for game producers, but it’s now expanded significantly through a mix of organic growth and acquisition.
Keyword’s recent results showed that half-year sales rose by 50% to €63.8m, while adjusted pre-tax profit rose by 60% to €9.6m. Adjusted earnings rose by 55% to 13.2 euro cents per share, putting the stock on a trailing 12-month P/E of 62.
This is a demanding valuation, but I’m tempted to say that it’s fair. One reason I’m positive is that the profitability of Keyword Studios is improving steadily. Operating margin was 11.9% during the first half, up from 10% for the same period last year. The group is also highly cash generative, meaning that despite regular acquisitions, debt levels are still very low.
Analysts expect earnings to rise by 41% this year and by a further 24% in 2018. That gives the stock a 2018 forecast P/E of 43. I’m not bold enough to buy at current levels, but I would continue to hold.