Mulberry priced for perfection

Anyone who's ever bought designer clothing probably knows that the items aren't really worth what they're paying - true, the items tend to be better quality than mass market high street ones, but a significant chunk of the price tag is the cost of buying into the brand. The same is true of shares in the companies that make them, which might be a good reason to sell shares in Mulberry.

Luxury goods designers have seen their valuations run wild, as investors look to tap into the huge demand from the newly wealthy population of fast growing economies they're experiencing. Exposure to China's high-end shoppers, who are keen to flaunt their riches, is seen as particularly important. The country's expenditure on luxury goods is expected to double between 2010 and 2015, and luxury goods brands are investing heavily in their presence there and in other fast growing economies like Russia.

In the UK, Burberry and Mulberry have been key beneficiaries of this trend, with the latter's rapid share price climb particularly eye-catching. Its shares have risen eight-fold in the last year, from just 200p to a high of 1,628p last month.

That partly reflects the improving trajectory of the business. The posh handbag maker has upgraded earnings guidance continually over the past two years, helped along by spectacular sales growth - in the last half year alone, like-for-like sales climbed 47 per cent, and orders for the Spring/Summer 2011 season were up 91 per cent. It's seen further improvement since, with an upgrade of expectations for the full-year results due to be delivered on 16 June.

However, we still don't think that investors should be seduced into paying a premium for the shares, in the same way that the fashion conscious pay over the odds for a handbag. To buy into Mulberry's current valuation - the company now has an eye-watering market capitalisation of over £800m even though it is only expected to report pre-tax profits of £21.5m in its latest financial year - you have to believe that luxury goods demand will not falter, and that the business will keep delivering earnings upgrades. We think the price is ignoring the very real risks of economic uncertainty both at home and overseas, and demands perfect execution in the design studio and throughout the distribution network, much of which is operated by franchises in fast-growing markets.

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Hope of a takeover that has helped drive huge share price appreciation also looks optimistic. Singaporean businesswoman Christina Ong already owns 57 per cent of the company via her holding company, Challice, wrestling the remaining stake from founder Roger Saul as long ago as 2003, with Luxembourg investment bank Banque Havilland holding a further 25 per cent. She also has representation on the board in the form of her daughter, Melissa Ong, who became a non-executive last year and, although the family has recently been selling shares, offloading 500,000 back in January, it seems unlikely that they'll want to sell their entire holding. It's equally hard to imagine that a third party buyer could justify the current price tag for such a specialist brand, which has struggled to diversify into other product areas such as menswear, footwear and jewellery, unlike more broad-based Burberry.

A small free float also means that the stock is very poorly covered by analysts, with only house broker Altium Securities providing forecasts. Under-researched stocks are the most likely to be mispriced - usually it's a good way of spotting bargains, as Mulberry was a couple of years ago, but the relationship works both ways. Stocks can be mispriced too highly as well and the limited free float can exaggerate price moves in either direction.