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Top broker urges investors to take profit on one of the best-performing retail shares

The share price of Lovisa Holdings Ltd (ASX: LOV) is taking a battering today after Morgan Stanley warned that the stock has overshot to the upside and is urging investors to take profit.

The costume jewellery retailer is one of the superstars in the retail sector with the stock surging 172% over the past 12 months when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) is up 11%.

The outsized returns by Lovisa are even more notable when you contrast it to the gloom among retailers like Harvey Norman Holdings Limited (ASX: HVN) and Myer Holdings Ltd (ASX: MYR) as their businesses suffer from the shift to online shopping and anaemic wages growth.

But Lovisa tumbled 2.4% to $10.68 in the last hour of trade, after Morgan Stanley downgraded the stock to “underperform” from “neutral” on valuation concerns.

Lovisa is no bargain buy with the stock trading close to 30 times price-earnings (P/E) based on the broker’s FY19 estimates.

That’s even more than the 20 times P/E that stationery and fashion retailer Premier Investments Limited (ASX: PMV) is on and that’s one stock that usually trades at a premium to the sector.

Lovisa is even more expensive than fast-growing online retailer Kogan.com Ltd (ASX: KGN), which is on a FY19 consensus P/E of 23 times.

This isn’t to say there aren’t any fashion retailers that can hold a P/E of more than 20 times over a long period. You just have to go overseas to look for them and Morgan Stanley pointed out that NASDAQ-listed Lululemon Athletica inc. is one such stock.

The question though is whether Lovisa is anything like the sportswear company. Morgan Stanley believes there are five factors that drive the outperformance of Lululemon. They are globalisation, digital traction, product innovation, category expansion and passionate people.

Based on these five factors, the broker doesn’t believe Lovisa fits the bill as the most number of boxes Lovisa can check is three out of the five, said Morgan Stanley.

On the other hand, Lovisa’s international expansion could prove to be more successful than the market is expecting, and the retailer’s management team looks to be among the best in the business.

However, I think Morgan Stanley is right in encouraging shareholders to take profit now as the stock looks overbought to me even with the potential upside.

The market volatility from nervous investors eyeing global macro events should create buying opportunities for Lovisa should the stock retreat significantly from its current level.

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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 Premier Investments Limited. The Motley Fool Australia has recommended Kogan.com ltd. 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 Scott Phillips.

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