What is Valuation Risk? Are High Growth stocks facing Valuation risk?

Growth stocks

When there is a risk that a financial asset is overvalued and there is a chance that it will bring lesser return than what is expected, that financial risk is known as Valuation Risk. Investment fund managers generally try to minimise the valuation risk when they are making investments.

Recently, many top fund analysts reported that several high growth stocks with high P/E multiples are currently facing valuation risk as they believed to be overvalued and are expected to come down in future. This is why several fund analysts have decided to short companies with high P/E multiples in order to avoid any future uncertainty.

One of the companies with high PE Multiple is CSL Limited (ASX: CSL), a leading healthcare company, which is currently trading at a PE multiple of 39.230x as on 19th July 2019. In the last one-year, CSL’s stock has witnessed a rise of 12.43% and is currently trading at a price of $224.780, with a market capitalisation of circa $101.7 billion.

Many technology stocks, considered as high growth stocks, are also getting overlooked by many fund managers as they believed to be overvalued.

One of the best performing technology stock of recent time, Afterpay Touch Group (ASX: APT), a technology driven payment company, was recently in news when many top fund managers confessed of overlooking APT, as it is hard to value, due to its unpresidential returns, rising substantially by over 115% in last one year.

APT’s one of the biggest competitors, ZIP Co Limited also has witnessed significant growth in term of share price, rising significantly by 176.32% over the last six months. The stock has a 52-week high price of $3.980 and 52 weeks low of $0.835, with an average volume ~3,190,041.

In a current market scenario, it is very important for investors to recognise the warning signs of future poor returns of a stock. P/E multiple should not be the only criteria to value a stock. Careful analysis of a stock fundamentals could be helpful in these scenarios.

Stocks with high P/E multiple:

Magellan Financial Group Limited (ASX: MFG)

A global investment firm, Magellan Financial Group Limited (ASX: MFG) currently has a P/E multiple of 29.890x and an annual dividend yield of 2.9%. In the past six months, the stock price has increased by 102.18% as on 18th July 2019. At market close on 19th July 2019, MFG’s stock was trading at a price of $58.00, near its all time high of $59.740.

At the end of June 2019, Magellan had total FUM of $86,718 million. In the month of June 2019, FUM witnessed a net inflows of $488 million, taking average FUM for the 12 months ended 30th June 2019 to $75.8 billion, around $16 billion higher than pcp.

Cochlear Limited (ASX: COH)

The stock of healthcare company, Cochlear Limited (ASX: COH) is currently trading at a P/E multiple of 48.450x. COH’s stock is trading at a price of $219.110, with a market capitalisation of circa $12.8 billion. The stock has 52-week high price of $225.450 and 52 weeks low price of $155.220, with an average volume of ~162,510.

One stock with Decent P/E Multiple:  Super Retail Group Limited (ASX: SUL)

One of Australia’s leading retailer, Super Retail Group Limited (ASX: SUL) currently has a P/E Multiple of 14.500x. In the last six months, the share price of SUL has increased by 39.79% as on 18th July 2019. SUL’s stock is currently trading at a price of $9.430, around $1 short of its 52 weeks high price of $10.440. SUL has a market cap of $1.85 billion and total outstanding shares of 197.38 million.

In the month of April, the company reported encouraging trading performance for 52 weeks to 27th April 2019. The company reported strong sales growth in all its business, particularly in Macpac, which witnessed a total growth of 17.8% on a like-for-like basis as compared to pcp. The company’s Auto and Sports businesses have also performed well, consistent with the expectations.

Sales growth compared to the prior comparative period (Source: Company Reports)

Along with the valuation risks, there are several types of investment risks, which one needs to keep in mind while making investments. With any investment, there involves a degree of risk. Generally, investment risk is a chance that the outcome will be different to what is expected. The types of investment risks, which may have an impact on investment are as follows-

  • Individual Asset Risk – The risk attributable to individual assets within a particular asset class.
  • Market Risk – The risk of major movements within a particular asset class.
  • Political Risk – The risk that domestic and international political events can impact on investment.
  • Inflation Risk – The risk that money may not maintain its purchasing power due to increases in the price of goods and services (inflation).
  • Timing Risk – The risk that, at the date of investment, money is invested at higher market prices than those available soon thereafter. Alternatively, it can also mean the risk that, at the date of withdrawal, investments are redeemed at lower market prices than those that were recently available or that would have been available soon thereafter.
  • Investment Manager Risk – The risk that a particular investment manager will underperform.
  • Credit risk – The risk that a debt issuer will default on payment of interest or principal.
  • Liquidity risk – The risk that investors will be unable to redeem their investment at their chosen time.
  • Currency Risk – The risk that overseas investments gain or lose value as a result of a fall or Rise in Australian dollar. Details of the risk that apply to each of the investment options are set out in the table on the following page.

An investor or fund manger should keep all these risks into consideration while making investments.


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