Within the bull stock market of recent years, it’s perhaps of little surprise that some companies are overvalued. Investor sentiment has improved dramatically, and the growth prospects of a number of businesses now appear to be fully priced in. As such, it could make sense for investors to sell those stocks in favour of shares which could offer greater upside potential.
With that in mind, here are two companies which now appear to be overvalued based on their future growth prospects.
Improving performance
Reporting on Monday was engineering data and design IT systems provider Aveva (LSE: AVV). The company reported a positive trading performance in the first nine months of its financial year, with an improving growth trend across all reporting regions. There was a particularly good performance in Asia Pacific, with a sharp focus on sales execution a key contributor. There was also a stabilisation of conditions in the Oil & Gas- and Marine-end markets.
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The company’s improving performance means that it’s ahead of previous sales expectations for the period. This has helped to improve investor sentiment, with the company’s shares moving as much as 3% higher. News of a contract win with a key Global Account EPC customer may also have helped to push the company’s share price higher on Monday.
A rising share price takes Aveva’s capital gain to 51% in the last year. This puts it on a price-to-earnings (P/E) ratio of 43. Given that it’s expected to report a rise in earnings of 6% this year, and 8% next year, this appears to significantly overvalue the stock. As such, a lack of further growth could be ahead, which may make it a stock to sell at the present time.
Narrow margin of safety
Also lacking upside potential is fellow Software & Computer Services sector company Softcat (LSE: SCT). It also appears to be grossly overvalued given its growth outlook.
Certainly, expectations of a growth rate in earnings of 8% in the current year and next year are higher than for the wider index. However, after a share price gain of 73% in the last year, the company appears to lack a sufficient margin of safety to merit investment. Its P/E of 24 translates to a price-to-earnings growth (PEG) ratio of 3, which is relatively high. That’s even the case following the FTSE 100’s Bull Run of recent years, with the index and many of its incumbents trading at record highs.
Certainly, Softcat is making good progress as a business. It appears to be delivering on its strategy, and it could report above-average profit growth figures over the medium term. But with investors seeming to be overly enthused about its future, it may be prudent to sell it and invest elsewhere. In this case, a good business does not necessarily equate to a good investment opportunity.
