Why I’m avoiding this stock despite 22% profit growth forecast for 2017

This company’s shares appear to be overvalued despite its upbeat outlook.

Peter Stephens ❯

Having held various senior management positions in the manufacturing sector, Peter founded his own manufacturing company in 1996. This was subsequently sold in 2007. Meanwhile, his passion for investing (which began during the privatisations of the 1980s) remains strong and he couples this with writing for The Motley Fool as a Contractor. His investment style is value-oriented; focusing on company fundamentals, as well as assessing the strength and presence of a competitive advantage. While above-average growth prospects remain very attractive, a greater focus on dividends has crept in since Peter became a part-time retiree in 2007.

Published 22 February, 2017 2:50 pm GMT

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

While it is always tempting to follow other investors and buy shares in fast-growing companies, being a contrarian investor could be more profitable. It may allow you to buy shares which are unpopular, thereby providing significant upward re-rating prospects. Similarly, it may mean you avoid stocks which prove to be somewhat overvalued. Reporting on Wednesday was a company which, while among the top performers for the day, may prove to be a disappointing investment in the long run.

Upbeat outlook

That company is events specialist UBM (LSE: UBM). It reported better than expected results for the 2016 financial year on Wednesday. Its continuing revenue increased by over 12%, while continuing adjusted operating profit was 19.2% higher. This shows that the company is performing well following the disposal of PR Newswire and the acquisition of Allworld Exhibitions. This has refocused the company on the business-to-business (B2B) events sector, which seems to offer significant growth potential.

In fact, in the current financial year UBM is expected to record a rise in its earnings of 22%. This is around four times the expected growth rate of the wider index. Clearly, there is scope for a difficult period for the global economy, but UBM believes that the integration of Allworld could have a positive impact on its bottom line. Furthermore, it believes that its current strategy will drive margin improvement, which would help to offset any pressure on sales over the coming year.

Passive income stocks: our picks

Do you like the idea of dividend income?

The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?

If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…

Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.

What’s more, today we’re giving away one of these stock picks, absolutely free!

Get your free passive income stock pick

Valuation

Despite its impressive performance and upbeat outlook for 2017, UBM’s valuation appears to price in its future potential. For example, in the 2018 financial year it is expected to record a rise in earnings of just 3%. Using its current price-to-earnings (P/E) ratio of 19, this equates to a price-to-earnings growth (PEG) ratio of around 6.3. This indicates that while its shares may be popular at the present time, they could lack upside potential over a longer term timeframe.

That’s especially the case when UBM’s sector peer WPP (LSE: WPP) trades on a P/E ratio of 16.9 and is forecast to increase its earnings by 15% this year and 9% in 2018. This puts it on a PEG ratio of just 1.4, which indicates that it offers substantially more capital gain potential than UBM.

Risks

Furthermore, UBM’s risk profile may be higher than that of its sector peer. It is in the midst of a major restructuring which is turning it into a more concentrated business which focuses on events. While this may lead to higher growth in the long run, it could lead to uncertainty and integration challenges in the short run.

While WPP is likely to engage in M&A activity this year, it has a long history of making acquisitions work. Therefore, its business model may be less risky than that of UBM at the present time. As such, buying the less popular of the two companies (i.e. WPP) may prove to be the best option, in my opinion.