With the FTSE 100 trading close to a record level, it's perhaps unsurprising that some stocks appear to be overvalued. After all, the index has experienced a major Bull Run in recent years. And while stocks with high price tags may offer strong growth potential, the reality is that they can come with sizeable risks.
One example of a stock that appears overvalued is Intertek(LSE: ITRK). It released a relatively positive trading statement on Tuesday but still appears to offer little margin of safety. As such, the quality assurance service provider could be worth selling in favour of one of its index peers.
Intertek's revenue has grown 9.8% during the course of 2017. However, the majority of this was because of favourable currency gains, with the constant currency growth rate being much lower at 3%. In fact, organic revenue growth at constant exchange rates was just 1.9%, with its Resources sector being the main reason for a somewhat disappointing overall performance. It recorded a decline in revenue of 10.3% and while this was offset by sales growth in the Products (5.5%) and Trade (4%) divisions, the overall performance of the business is clearly mixed.
The performance of the company's acquisitions continues to be strong. It's also making improvements on operational discipline regarding cost and margin management. Cash conversion has been impressive and this could allow the business to reinvest for future growth.
With Intertek expected to report a rise in its bottom line of 8% next year, its current valuation appears to be excessive. It has a price-to-earnings (P/E) ratio of 28, which suggests that there's little upside potential on offer unless the company can deliver significantly better earnings growth than its guidance.
By contrast, fellow FTSE 100 stock British American Tobacco(LSE: BATS) has a P/E ratio of 17.5 and yet is forecast to deliver the same 8% earnings growth rate for next year. In addition, the tobacco giant may have more scope to generate higher profit growth in future years due to its exposure to the e-cigarette and next generation products segment. This could generate around £5bn in sales by 2022, which may act as a catalyst on its share price.
Stronger customer loyalty
Furthermore, British American Tobacco may prove to be a more defensive share than Intertek. It benefits from a higher degree of customer loyalty and is less dependent on the macroeconomic outlook than its index peer. Alongside a lower valuation and strong growth prospects, this may provide the company with a superior risk/reward ratio.
At a time when it is fairly easy to overpay for a variety of stocks, British American Tobacco appears to have a relatively wide margin of safety. As such, it could be worth selling an apparently overvalued stock such as Intertek in order to buy into this one -- especially with the FTSE 100 trading close to a record high.
Peter Stephens owns shares in British American Tobacco. The Motley Fool UK has recommended Intertek. 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.