FTSE 100-member SSE’s share price is in freefall! This is what I think you should do

Arrow descending on a graph
Arrow descending on a graph

Declining FTSE 100 shares are nothing new. After all, the index has fallen by 12% since reaching an all-time high in May 2018. However, the drop in the SSE(LSE: SSE) share price of 21% during the same period is perhaps surprising to some investors. The company has been a popular income share in recent years, with it apparently offering a defensive profile.

The business is experiencing a period of heightened risk, however. As such, its shares have delivered poor performance relative to the wider FTSE 100. Yet there could be turnaround potential ahead. That’s especially the case while a number of stocks, such as a FTSE 250 company which released a disappointing update on Friday, continue to be overpriced in my opinion.

High valuation

The company in question is cloud-enabled end-user and network security specialist Sophos(LSE: SOPH). Its performance in the first nine months of the year has continued to be subdued, with billings growing by just 2% in the period. A further sequential improvement in the renewal rate to existing customers in the third quarter was offset by a modest decline in new billings from new customers, as well as a decline in hardware billings.

Investors reacted negatively to the update. The company’s share price declined by over 20% following its release. This means that in the last year, its share price has dropped by around 55%.

Looking ahead, Sophos is forecast to post a rise in earnings of 17% in the current year, followed by growth of 13% next year. While this is a positive outlook, the stock has a price-to-earnings (P/E) ratio of 37, even after its recent decline. As such, it seems to lack a margin of safety and may be worth avoiding.

Recovery potential

As mentioned, SSE faces a number of risks which appear to have contributed to a decline in its share price in recent months. Perhaps its most pressing challenge is the disappointing financial performance which has been recorded in recent quarters. The company released a profit warning in September, with the impact of a price cap on variable tariffs and poor weather conditions being major contributors. The business is also facing uncertainty in terms of its strategy, with plans to merge its energy supply operations with Npower being scrapped.

While SSE has experienced a disappointing period, it may now appeal to value investors. The stock trades on a P/E ratio of 9.8, which suggests that investors have factored in the potential for further challenges. It has a dividend yield of 7.5%, and is expected to raise shareholder payouts by at least as much as inflation over the medium term.

As such, the income and value potential of the stock seems to be high. Certainly, it may be unable to provide a resilient and robust investment opportunity during what is proving to be a turbulent period for the FTSE 100. But from a recovery perspective, it could deliver high returns over the long term.

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Peter Stephens owns shares of SSE. The Motley Fool UK has no position in any of the shares mentioned. 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.