The Perils of Growth Investing (Part 1)

Posted on 15/12/2010


This is the first in what I expect could eventually be a long series of examples of how investing in “growth” business at high valuations can result in a serious loss of capital.  The chart below shows the share price of Betfair, a company which operates a peer-to-peer online gambling exchange.  The company sold off 15% of its shares at £13 per share, jumping 19% on the first day to close at £15.50.  However, it was downhill from there, with sell-side analysts publishing largely-negative research pieces on the grounds of valuation.

The IPO price valued Betfair at a market capitalisation of £1,390m, which compares to profits in the year to April 2010 of £17.8m, a multiple of 78x.  On December 14th the company released results for 1H11 and disappointed the market with revenue growth of only 1.6% year-on-year in the second quarter, leading the share price to fall by 15% on the day.  The current estimate of net income for 2011 is £31m, so despite the recent share price fall Betfair is still trading at a 36x multiple of 2011 earnings.  The sluggish revenue growth, combined with potential regulatory risks, increasing competition and the high valuation multiple suggests there could be further declines in the share price in 2011.