Picture supply: Getty Photos
When assessing FTSE 250 shares, I all the time take a look at valuation metrics to get an concept of a inventory’s progress potential. One of the vital standard such metrics is the price-to-earnings (P/E) ratio. It provides a fast concept of how the inventory’s worth stacks up towards its current earnings.
A superb common is often round 20, with something under 15 suggesting potential undervaluation.
The issue is, it doesn’t all the time inform the total story. In style progress shares, significantly these in know-how, can have P/E ratios within the tons of — and nonetheless see their share costs climb!
So to get a extra correct concept of the place issues are headed, I all the time test earnings forecasts. With these, I can calculate the ahead P/E ratio, evaluating the value to anticipated earnings within the coming yr.
I just lately utilized this strategy to the respiratory tools firm Avon Applied sciences (LSE: AVON).
A better take a look at Avon
Avon designs and manufactures superior respiratory safety tools utilized by army, regulation enforcement and hearth personnel. Its merchandise embrace the FM50 respirator, which just lately secured a £10.2m order from the Ministry of Defence (MoD). This deal provides to an already robust order ebook, suggesting wholesome money move over the subsequent yr.
The market has taken discover – the share worth has surged 66.8% prior to now 12 months. Nevertheless, the valuation seems to be lofty at first look, with a trailing P/E ratio of 127.2 and a price-to-book (P/B) ratio of 4.78.
On the floor, these numbers scream overvalued. However once we think about forecast earnings progress, the image adjustments. Analysts count on earnings per share (EPS) to rise from 67p to 86p by 2026 – a 30% enhance. That provides Avon a way more palatable ahead P/E ratio of round 30. Income can also be projected to develop by 7% to £242.3m.
Importantly, full-year earnings have overwhelmed expectations three years working. Plus, working margins are set to climb from 9.7% to 12% in 2025 — one other encouraging signal of effectivity positive aspects.
That mentioned, margins stay skinny in comparison with some friends, that means there’s much less room for error. If gross sales momentum slows or manufacturing prices rise, income may take a success. Avon’s working money move of £23.4m can also be modest when set towards whole debt of £65.3m (though that is well-covered by fairness).
One other issue to think about is Avon’s reliance on massive authorities and army contracts. Whereas profitable, these may be delayed, scaled again, or cancelled because of price range adjustments or shifting geopolitical priorities. This focus danger means outcomes could also be extra risky than these of extra diversified producers.
A promising funding
To me, Avon seems to be much less overvalued than its trailing P/E suggests. The wholesome ahead outlook is backed by a strong order ebook and confirmed execution, as proven by repeated earnings beats.
There are nonetheless dangers, notably its comparatively skinny margins and publicity to authorities budgets. However the progress forecasts and rising working effectivity counsel a enterprise shifting in the precise route.
For buyers searching for oblique publicity to the defence sector with out shopping for a conventional arms producer, Avon Applied sciences is a promising candidate to think about.
