While it is rare to find a high-quality company trading at a dirt-cheap price, paying over-the-odds for any stock may not be a prudent move. Certainly, they may deliver high returns in the short run as improving investor sentiment propels them higher. However, in the long run they may struggle to deliver outperformance versus the index if their results fail to represent major gains versus prior years.
Here are two stocks which appear to be overvalued at the present time, and potentially worth avoiding for the time being.
Reporting on Friday was defence, security, transport and energy company Ultra Electronics(LSE: ULE). Its performance in the year to 27 April showed that it is delivering on its previous guidance. The company's trading and cash performance in the period was as per expectations, with its outlook for the full year being in line with expectations. It anticipates that its performance for the full year will be more weighted towards the second half than in prior years. This is because of the current six-month Continuing Resolution to US Federal funding.
Looking ahead, Ultra Electronics is expected to report a rise in its bottom line of 3% in the current year, followed by additional growth of 7% next year. This means that its outlook is less upbeat than for the wider index, and as such it would be unsurprising for the company's shares to offer a wide margin of safety.
However, Ultra Electronics trades on a price-to-earnings (P/E) ratio of 15.6. This indicates that it has a growth valuation, and yet lacks above-average growth prospects. When its rating is combined with its forecast growth rate, the company's price-to-earnings growth (PEG) ratio of 3.1 suggests that now may not be the right time to buy it.
While the defence sector could experience an improving outlook thanks to higher spending under Trump's proposed spending plans, defence specialist Cohort(LSE: CHRT) has an uncertain outlook. It is expected to report a fall in its bottom line of 11% in the year to 30 April 2017. Although it is forecast to reverse this with growth of 25% in the next financial year, it is then expected to record negative growth of 6% in the following year.
As such, the company's prospects appear to be somewhat volatile. This could cause investor sentiment to come under a degree of pressure. That's especially the case since the company's shares trade on a P/E ratio of 17.7, which indicates that they are overvalued at the present time.
Looking ahead, the defence sector could be a sound place to invest for the long term. Despite its improving outlook, there are a number of defence stocks offering a wide margin of safety as well as rising profitability. Therefore, I believe there appear to be better opportunities for long-term growth than those offered by Cohort right now.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has recommended Cohort. 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.