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Five expensive stocks that can keep on growing

28 March 2014

Rising markets over the past five years have encouraged investors to look for cheap areas of the market, but FE Alpha Manager James Thomson offers them a word of warning.

By Joshua Ausden,

Editor, FE Trustnet

Investors looking to low-quality areas of the markets for bargains are playing with fire, according to manager of the Rathbone Global Opportunities fund James Thomson, who is sticking by his principle of finding quality companies that can continue to grow.

ALT_TAG FE Alpha Manager Thomson (pictured), who has led his fund to top quartile returns in its IMA Global sector over a one, three, five and 10 year period, says he is avoiding battered stocks and sectors – including emerging markets and the miners – because the risk of permanent loss is so high.

He says a deep value approach to investing could have been applied to Russia in 2012 or HMV in 2010 – both which have severely disappointed since then.

“There are lots of cheap companies on single digit P/E [price-to-earnings] ratios which are just about to have a profit warning,” he said.

The manager says expensive growth stocks with a growing market share are always susceptible to single day sell-offs if they disappoint, but for a longer-term investor they provide a good balance of returns and stability.

Here, Thomson highlights five apparently expensive companies that he thinks can continue to deliver strong returns.


ASOS


“This is the perfect example – when ASOS was 5p it was expensive, and at £65 a share it’s still expensive,” he said.

“These companies look expensive from the outside, but their innovation and ability to take market share markets their earnings growth justified.”

Since Thomson made these comments earlier in the month, ASOS has suffered a significant correction of around 20 per cent. The manager remains confident in the stock however, insisting such an occurrence is typical.

“A common risk of high-growth investing is that these type of companies are prone to maddening pullbacks, proving why these kind of stocks are not really for short-term investors,” he explained.

Performance of stock vs index over 5yrs


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Source: FE Analytics

“ASOS announced slower sales growth and sluggish margin improvement, as they invest for the next phase of growth. The stock was priced for perfection and has sold off.”


“However, we believe the customer proposition for ASOS remains market-leading. Sales growth has already bounced back in March and management are preparing for a time when they sell £2.5bn worth of clothes a year – it was £770m in 2013.”

“We currently hold around 2 per cent in the fund but are considering buying more,” he added.

The AIM-listed online retailer is currently trading at £51 a share. It remains one of the most expensive stocks in its index however, trading on a forward P/E ratio of 87 times.

ASOS is a top-10 holding for 13 funds in the IMA unit trust and OEIC universe, including Thomson’s fund and Harry Nimmo’s Standard Life UK Smaller Companies portfolio.


AB Foods


“AB Foods is another one. It derives a lot of its profits from Primark, which is another company that has shaken up its sector,” said Thomson.

“I spoke to management recently and asked what it’s fastest growing regions were and it said Spain and Portugal – I don’t know how many companies can say that. It’s also very fashionable in France. This is a company that I think can keep on growing.”

AB Foods is trading on a forward P/E of 28 times, making it one of the most expensive stocks in the FTSE 100. Rathbone Global Opps and Marlborough UK Multi Cap Growth are among seven funds that hold the stock in their top-10.

FE data shows AB Foods has returned almost 400 per cent over five years, and almost 200 per cent over three.


B/E Aerospace

Thomson’s biggest regional position by a distance is the US, which he says has the biggest offering of quality growth companies. He highlights B/E Aerospace, which manufacturers aircraft cabin interior, as one of his favourites.

“I’m always looking for companies with good innovation, and this ticks that box,” he said.

“They’ve recently built a new aeroplane toilet which is smaller than the existing model, and allows 737 aircrafts to fit between two and six extra seats.”

“It’s not very glamorous but it’s worth $800m thanks to a recent deal with Boeing.”

“The airline industry is in rude health, with order books stretching out for many years. I like to find interesting and lesser-known ways of playing a wider theme, and so instead of owning Boeing, I hold B/E Aerospace.”

The company has had a great run since it made its deal with Boeing just over two years ago, and is currently trading on a forward P/E ratio of 20 times.


Rightmove

Thomson points to Rightmove, another expensive stock which is trading on a forward P/E ratio of 28.5 times, as a stock he is tipping for future growth.

“This is another ASOS – at £3 it was expensive and now at £26 it’s expensive,” he said.

“People will say a stock on a multiple in the high twenties is too expensive, but this is a company with 80 per cent market share.”

“It has incredible pricing power, growing its revenue per estate agent by an average of 25 per cent a year since 2004. I haven’t seen pricing power like that in my entire career.”

FE data shows the FTSE 250 stock has returned more than 1,000 per cent over a five year period, making it one of the best performing stocks in the FTSE All Share.


Performance of stock vs index over 5yrs

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Source: FE Analytics

Fifteen IMA funds hold Rightmove in their top-10, including Nigel Thomas’ AXA Framlington UK Select Opportunities portfolio.


Dignity


Last but not least, Thomson points to FTSE 250 funeral specialist Dignity as a stock he’s more than willing to pay up for.

“This offers funeral services including cremation,” said the manager. “I don’t want all of the stocks in the portfolio to be racy tech plays – I also want some which deliver reliable revenue growth that aren’t tied to the performance of the economy.”

“Dignity certainly fits into this bracket – it’s sad, but there is nothing more reliable than death. Earnings are very predictable, with a low to single digit increase in pricing power every year.”

Dignity, which has delivered at least 16 per cent every calendar year since 2010, is trading on a forward P/E ratio of 18.5 times. Unicorn Outstanding British Companies and MFS Meridian European Smaller Companies are the only two funds that hold the stock in their top-10.

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