Shares in Sage Group (LSE: SGE) have been soaring in 2019, gaining 55% since their recent low point in October 2018.
But looking back a bit further, we see 2018 was a year of slump, after the small business software specialist came off a previous impressive bull run to the end of 2017.
Looking at that record, my colleague G A Chester recently voiced some misgivings about Sage’s valuation, seeing a toppy P/E of around 26 as a bit stretching, and suggesting it’s based on the firm’s historical growth and margin targets, which he reckons might no longer be realistic.
A 12% share price fall on Thursday after the firm released a third-quarter update, the stock’s biggest one-day fall in more than a decade, suggests Mr Chester got it right.
Cloudy outlook
The problem is that the transition to cloud-based software, which Sage was slow at getting under way, and the shift away from offline software is proving difficult. The result is a drop in licensing revenue that’s bigger than expected.
Although the firm reported a 5.3% rise in total organic revenue in the quarter, with a 5.9% rise in the first nine months of the year, software and software related services (SSRS) revenue (that is, licensing revenue) fell 15.5% in the nine-month period, to £195m.
The shift to a subscription-based business model, which is increasingly the way software services are moving, was always likely to harm short-term revenue growth, but the latest news seems to have raised fears that the pain will be more severe than expected.
What we’re seeing, in my view, is exactly what has been happening to highly-valued growth shares for years — a single failing, however short term, is all it takes to drive fickle investors away and potentially kick off another slump.
My approach is simple — I just don’t buy highly-priced growth shares.
Bigger climb
Speaking of highly-valued software shares, industrial software specialist Aveva Group (LSE: AVV) has rewarded shareholders with a doubling of its share price in the past 12 months.
Full-year forecasts for 14% earnings growth this year got a boost on Thursday, after a first-quarter update spoke of “a good start to the financial year,” with “high-single-digit revenue growth.”
That forecast does, however, put the shares on a P/E of 38. To put it into perspective, EPS would have to grow 2.7-fold to bring the P/E down close to the FTSE 100 long-term average of about 14. And though things look positive right now, I can’t help fearing that any slight shortfall in meeting that stretching growth target in the coming years could precipitate a big share price drop.
Topping out?
The shares have doubled in the past two years, with 2019 so far alone bringing a 75% price gain. The ground for that was set by the firm’s merger with French energy group Schneider Electric in 2017. But while I’m happy for those who have seen such a handsome result, I really think I’d be taking profits if I held Aveva shares right now.
Some growth investors might believe they’re seeing a growth stock with a lot more to come, but in my view we’re looking at an overheating bubble. I reckon Aveva is a strong company, but I’d need to see a significant price fall before I’d buy.
