Why Purplebricks Group plc isn't the only overvalued stock I'm avoiding

With the FTSE 100 having experienced a major bull market in recent years, it's perhaps unsurprising that there are some shares which appear overvalued. After all, investor sentiment is generally favourable and this can mean valuations soar to what could prove to be unsustainable levels.

One company which seems to be a good example of such a stock is estate agent Purplebricks(LSE: PURP). Its share price has risen by 163% in the last year as investors have become more bullish on its growth story. However, it now appears to be grossly overvalued and could be worth avoiding.

Improving performance

Of course, Purplebricks continues to make progress with its strategy. It has been able to generate performance which is in line with its expectations in the UK despite a challenging market. While house prices may still be rising across the UK, the supply of homes and the turnover of housing remains low. This means that trading conditions for estate agents have been tough, and may remain so over the medium term as confidence in the economic outlook for the UK remains at a low ebb.

Possibly in response to this, the company has developed its operations outside of the UK. It's performing to expectations in Australia and the US, with both markets offering significant upside potential for the long run. As well as creating a further path to growth for the business, international expansion also means it is less reliant on the UK for future profitability.

Overvalued

While Purplebricks may be making good progress from a business perspective, its investment potential seems to be somewhat limited. Certainly, it's expected to move from loss to profit in the 2019 financial year, and this could cause investor sentiment to improve. But with it trading on a forward price-to-earnings (P/E) ratio of 231, it seems as though investors have already priced in its future prospects. As such, after a staggering share price rise in the last year, it could be a stock to avoid.

Modest growth

Also seemingly overvalued is XP Power(LSE: XPP), the developer and manufacturer of critical power control components for the electronics industry. The company released a positive trading update on Friday that showed a strong finish to 2017, performing in line with expectations. Order intake in the final quarter of the year was up 24% on the prior year, while revenue was 16% ahead. With strong growth across all regions, 2017 was a successful year for the business.

Looking ahead, XP Power is forecast to increase its bottom line by 6% in the 2018 financial year. While not a particularly low rate of growth, it's not the level of increase which a growth stock would be expected to deliver. Yet the stock continues to trade on a growth valuation. It has a P/E ratio of 26, which suggests that it may be overvalued at the present time. As such, after doubling in the last year, now may be the time to sell.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has recommended XP Power. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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