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Why this mid-cap market darling just got downgraded by Citigroup

It may be time to take profit on one of the market’s all-time favourite stocks given Citigroup downgraded ARB Corporation Limited (ASX: ARB), after yesterday’s 9.9% share price rally that came on the back of its profit results.

It was a strong result and there’s many things to like about it, but the broker thinks investors have gotten ahead of themselves with the stock rallying over 41% in the past 12 months, which has pushed its forecast price-earnings (P/E) to lofty heights of nearly 30 times for FY18.

In contrast, the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) is up less than 3% and has a P/E that is about half of ARB’s.

ARB is not a blue-sky IT stock that can support such large market premiums, after all.

Or can it?

If you look at its share price chart since it floated in the late 1980s, it has been on pretty much a one-way trip apart from a taking a bit of a spill in early 2017.

You only need to look at some high-flying IT-related stocks that have come crashing back to earth to appreciate ARB’s track record too. We are looking at you GetSwift Ltd (ASX: GSW) and Big Un Ltd (ASX: BIG)!

I am not suggesting that ARB’s P/E of around 30 times isn’t a little high but I think we do need to adjust our perceptions of what constitutes a too-rich premium.

ARB could very well return some of its recent gains as the lack of guidance and management’s admission about the difficulty in forecasting earnings will add a layer of uncertainty, but any pullback is likely to be relatively shallow, in my opinion.

Citigroup has also highlighted a number of growth levers in the business, such as ARB’s Thailand expansion with the company building new warehousing facilities to increase capacity.

The company is also off to a strong start in the second half of FY18 with the broker noting that car sales in ARB’s key categories are up 16% in January, and ARB has the opportunity to leverage on its new distribution capabilities as sales are unlikely to slow anytime soon.

“In 2H18, we expect ARB to further distance itself from its competitors, gain further scale domestically with three new stores expected in 2H18 along with the recently renovated facilities and continued momentum in its export markets,” said the broker. It upped its price target on the stock to $22.43 from $17.85.

Keep ARB on your radar and be ready to buy the dips. There are very few stocks of this calibre on the ASX.

Meanwhile, fellow auto accessories supplier Bapcor Ltd (ASX: BAP) also produced a very pleasing profit result this week and investors are eagerly awaiting AMA Group Ltd’s (ASX: AMA) earnings report card.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Bapcor. The Motley Fool Australia has recommended ARB Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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