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Here’s a high growth stock that Terry Smith’s team is buying

Edward Sheldon, CFA
Businessmen teamwork brainstorming meeting.

When I’m researching stocks to buy for my portfolio, one thing I always like to keep an eye on is the trading activity of top fund managers such as Terry Smith and Nick Train. I find monitoring the trades of these experts can be a great source of investment ideas.

With that in mind, here’s a look at a stock Smith’s team has recently purchased for his investment trust, Smithson, which is focused on small- and mid-sized growth companies.

Fevertree Drinks

Smithson’s most recent factsheet reveals that in July, portfolio managers Simon Barnard and Will Morgan added Fevertree Drinks (LSE: FEVR). The position was initiated after the company’s share price fell 47% from its 2018 peak, resulting in an attractive valuation relative to the fund managers’ views in relation to the quality of the business and its growth prospects.

While there are no details in regards to Fevertree’s position size within the portfolio, the investment trust only holds 30 stocks, which suggests the fund managers are confident about its prospects. Given this bullish view, should private investors follow Smith’s team and purchase the premium mixer drinks company for their own portfolios? Let’s look at the investment case.

Valuation

While Fevertree’s share price has undoubtedly fallen a long way from its 2018 high, the stock still looks expensive, in my view. Currently, analysts are forecasting earnings per share of 57.5p for the year ending 31 December. At the current share price, that puts the stock on a forward-looking P/E of 40.

On last year’s earnings growth of 36%, that kind of valuation could be justified as the P/E to growth ratio (PEG) equates to just 1.1. Yet given that earnings growth of just 8% is expected this year, I think that multiple looks high, as the forward-looking PEG ratio is 5. Generally speaking, a PEG of around one or less is desirable, so I’m not seeing a lot of value here, relative to the company’s growth.

Broker downgrades

Another reason I’m a little cautious about the stock is that since the company’s interim results in late July – which the market didn’t like at all due to slower growth in the UK – brokers have been downgrading their earnings forecasts and price targets for the stock. For example, after the H1 results, Jefferies cut its price target by 11%, from 2,700p to 2,400p. This could hamper positive share price momentum in the short term.

Economic moat

Finally, another issue that continues to concern me with Fevertree is the group’s competitive advantage. The company certainly has a first-mover advantage when it comes to premium mixer drinks, but does it have a strong economic moat? Is there anything to stop other brands entering the market? I’m not convinced there is. Indeed, every time I go shopping for mixer drinks it seems there are new brands entering the market.

Weighing everything up, I don’t see a compelling investment case for Fevertree at present. Given the high valuation relative to the company’s slowing growth, I think there are better growth stocks to buy right now.

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Edward Sheldon owns shares in Smithson Investment Trust. The Motley Fool UK has no position in any of the shares mentioned. 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.

Motley Fool UK 2019