It always gives me pause for thought when directors sell shares. Especially if the directors are also the founders, if their disposals are massive and if the share price has risen stratospherically high.
This has just happened with two popular growth stocks. Are the directors signalling that these stocks are now overvalued? And should you follow suit and cash in?
Running a fever
Fevertree(LSE: FEVR) has had a great run, its shares increasing more then tenfold since floating on AIM at 134p in 2014. Two weeks ago, the supplier of premium carbonated mixers for alcoholic spirits announced that co-founder and deputy chairman Charles Rolls intended to sell 2.5m shares. In the event, demand from institutional investors was such that he sold 4.5m, netting him a cool £73m at 1,625p a share.
However, he continues to hold almost 13m shares (an 11.2% stake in the business), worth over £200m. Furthermore, having sold shares in the IPO and another chunk last year at 635p, his disposals certainly haven't foreshadowed a reversal in the price. I think Mr Rolls has simply done what most investors would do if they found that a single holding had come to represent a grossly disproportionate amount of their total wealth. Namely, take some profit.
Fevertree's share price has soared on the back of tremendous top- and bottom-line growth. The company reported a 49% increase in revenue and a 51% rise in earnings in its maiden results as a listed business. This accelerated to 71% and 87% the following year and to 73% and 101% last year.
The trailing price-to-earnings (P/E) ratio is over 70 at a current share price of 1,715p. Such a sky-high P/E would be acceptable if earnings were to continue increasing by a triple-digit percentage, but City analysts are forecasting growth to slow to mid-teens this year. In light of this rate of growth, the shares look too expensive to me on such a high earnings multiple.
Key director sales
Keywords Studios(LSE: KWS), which listed on AIM at 123p a share in 2013, is another company that's delivered tremendous growth. This technical services provider to the video games industry also announced major share sales by founding directors two weeks ago.
Non-executive Giorgio Guastalla sold just shy of 4m shares and chief executive Andrew Day sold 500,000. Together they netted almost £37m at 820p a share. Again, though, they retain decent stakes in the business -- 7.2% and 5.9%, respectively.
Possible problems and risks
Last year, Keywords increased its revenue by 67% and earnings by 61%, giving a trailing P/E of 45 at a current share price of 795p. But, as with Fevertree, earnings growth is forecast to moderate this year -- to 25% in Keywords' case.
The video tech firm's valuation isn't as rich as Fevertree's but still looks on the pricey side to me, particularly as multiple acquisitions are a major part of its growth strategy. As Keywords acknowledges, this is a complex, costly and time-consuming process, involving a number of possible problems and risks. To compensate for this, I'd be looking for a lower valuation than that currently on offer.
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G A Chester has no position in any shares mentioned. The Motley Fool UK has recommended Keywords Studios. 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.