Buying shares in companies which have delivered stunning capital gains in a short space of time is always tempting. It is difficult for any investor to feel as though they have missed out on double-digit percentage gains in a short space of time. However, going with the herd can be a disappointing experience. Often, the valuation of the company has already reached what is an unattractive level, and so it may be prudent to await a lower share price. Reporting on Thursday was a company which neatly fits into that category.
The company in question is molten metal flow engineering specialist Vesuvius(LSE: VSVS). Its shares moved as much as 18% higher on Thursday following its results. They showed that the company is making encouraging progress with its restructuring. It recorded benefits from those changes of £16.6m in 2016 and is targeting savings of a further £35m by the end of 2017. Its performance during the year was resilient and saw the company make progress in its long-term, structural growth markets of China, India and Brazil.
Vesuvius recorded a fall in revenue of 4% and a decline in trading profit of 1.5%. However, investors were more interested in its strategy update, with its improving cash flow and growth in return on sales improving sentiment in the short run. And since the company is confident in its near-term outlook, further share price gains cannot be ruled out over the coming weeks.
However in the medium term, the company's share price could fall significantly. It trades on a growth stock valuation, but appears to be anything but. For example, Vesuvius has a price-to-earnings (P/E) ratio of 21, which indicates that its shares are overvalued. Certainly, it is forecast to record a rise in its bottom line of 13% in 2017 and 7% in 2015, however this equates to a price-to-earnings growth (PEG) ratio of over two. This suggests a share price fall could be ahead, rather than further capital gains.
Of course, the general industrials sector to which Vesuvius belongs can command high valuations. The companies within the sector often offer global exposure and their long-term growth rates can be significantly above average. At the present time, they are also set to benefit from weaker sterling, which could add several percentage points to their growth rates.
However operating within the same industrial sector as Vesuvius is DS Smith(LSE: SMDS). It trades on a relatively low P/E ratio of just 14.3 and is forecast to record a rise in its bottom line of 7% next year and 6% the year after. This indicates that there is upward re-rating potential on offer, since the company appears to have a sound growth strategy.
Its focus on packaging also means it has a relatively stable earnings outlook, as evidenced by its double-digit earnings growth in each of the last four years. Therefore, while sector peer Vesuvius may be a stock to avoid, DS Smith could be a stunning growth opportunity for the long run.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has recommended DS Smith. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.