Nobody wants to overpay for a stock, and nor should they. Shares trading at high valuations can be risky, because profits have to rise rapidly to meet inflated expectations, leaving the stock price vulnerable to even a small setback.
Price is right
Valuation measures such as the price/earnings ratio (P/E), price/earnings growth (PEG) or price-to-sales (P/S) ratio aren’t the only measures you need to examine, but are worth checking to see if you are bagging a potential bargain.
Some of the best bargains can be found among stocks whose share prices have taken a beating. One of these is construction equipment rental specialist Ashtead Group (LSE: AHT), whose stock plunged by a third in the second half of last year, although it’s revived in recent weeks.
PEG-ged back
The group has heavy US exposure, generating around 85% of its earnings from the States, and was hit hard by China trade war fears and the impact of USÂ Federal Reserve rate hikes. In mid-November, its forward P/E multiple slumped to just 11.5 times, with a sub-1 PEG reading of 0.4.
That P/E number is even lower today at just 9.6 times forecast earnings, although the PEG reading has climbed to 0.6. Ashtead still looks a bargain on both counts, and although its P/S ratio of 2.2 is relatively high, it’s in line with the industry average.
Earnings growth
Ashtead boasts healthy historic earnings growth, with five years of double-digit increases ranging from 22% to 48%. Another 36% is expected in the year to 30 April, and although it slows after that to 16% and 7%, I’m still impressed.
Management is confident and revenues are rising at almost 20% a year. The yield is a lowly 1.5%, although that’s partly down to strong share price growth (119% in three years) and management has increased the payout by 34% over the last five years.
Smurfit for purpose
Packaging group Smurfit Kappa Group (LSE: SKG) also lost around a third of its value between summer and last October, but has also started to recover. One concern was that the group was running up large debts to fund its acquisition-fuelled growth. Investors are also worried about over supply in the market, with companies such as DS Smith, Mondi and Hong Kong-based Nine Dragons Paper all looking to boost capacity.
Smurfit’s shares now trade at 15.17 times earnings, against an average of 17.84 times for its sector. That’s well below its five-year high of 22.13, but above its low of 8.62. A P/S ratio of 0.74 isn’t too demanding.
Attractive package
The stock currently yields a modest 3.1%, but management policy has been progressive, as has increased its payout by nearly 40% in total over the past five years. A return on capital employed (ROCE) of 21.1% is another positive.
As Royston Wild notes, the corrugated packaging market has strong growth prospects due to e-commerce shopping growth. Smurfit has just signed an unsecured €1.35bn revolving credit facility that should reduce finance costs, extend the term of its debt facilities, and increase the flexibility of its capital structure. However, earnings growth looks set to flatten in 2019 and 2020. Of the two, Ashtead would be my preferred pick.