Investors have the tendency to chase performance. And we should stop. This is one of the primary reasons why Morningstar’s Mind the Gap study shows that investors underperform the investments in their portfolio by 1.7% a year. Read more about how to improve your performance by making better decisions.

The following 2 ASX share have been on a strong run. It can be tempting to assume those strong returns will continue into the future but our analysts believe they are significantly overvalued.

Sigma Healthcare SIG

Sigma Healthcare is an Australian pharmaceutical distributor, wholesaler and pharmacy franchisor. The revenue growth prospects and returns of pharmaceutical distribution are subdued due to ongoing Pharmaceutical Benefits Scheme, or PBS, price reform, and regulated wholesale gross margins being capped at 7% for community pharmacy. As a result, Sigma and its competitors are seeking to expand into unregulated revenue streams. In addition, pharmacy ownership is restricted to pharmacists, thereby excluding direct corporate ownership and requiring exposure via a franchise business model.The focus on cloud-connected devices has led to increased adherence, supporting both reimbursement rates and the resupply of masks and accessories.

Shares in non-moat Sigma are up 87% year to date and are materially overvalued as they trade at 141% premium to our fair value estimate. We think there is a significant risk of regulatory resistance and do not yet factor in Sigma’s potential acquisition of Chemist Warehouse in our base case. In contrast to the market’s reaction, we don’t think Sigma’s proposed remedies materially derisk regulatory clearance, given it doesn’t address other major competition concerns from the Australian Competition and Consumer Commission that we think stem from the significant structural advantage in vertical integration and market share that it would gain.

In addition, our preliminary estimate of forecast fiscal 2025 earnings for the merged group implies Sigma’s shares are currently trading at a forward P/E ratio of 33 times. This suggests minimal upside if the deal goes through as proposed, outweighed by the significant downside risk if Sigma cannot overcome all ACCC concerns. The rejection of the deal, as we expect, is a potential catalyst for the share price closing the gap to our fair value estimate of AUD 0.78 per share.

The ACCC provided a Statement of Issues in June, outlining competition concerns at retail and wholesale levels. Sigma has now proposed to address some concerns, specifically regarding the independent pharmacies it supplies and the potential misuse of confidential data. It may enable CW to access and use commercially sensitive data relating to independent pharmacies currently supplied by Sigma that CW competes with.

JB Hi Fi Ltd JBH

JB Hi-Fi operates more than 300 electrical and white-goods stores across Australia and New Zealand under The Good Guys and JB Hi-Fi brands. First the good news. We forecast a broad rebound in retail spending from fiscal 2025—owing to a larger workforce, higher wages, and meaningful tax cuts. This should benefit all retailers.

In August JB Hi-Fi reported the first quarterly sales increase compared to the prior period since 2022. As a result, we raised our fair value estimate by 9% to $41. However, the shares are up 50% year to date and are trading at a 94% premium to our fair value.

Despite the recent rebound in sales we see potential trouble ahead. JB Hi-Fi lacks an economic moat. The Australian discount electrical retailer has over 300 JB Hi-Fi and The Good Guys branded stores across Australia and New Zealand. JB Hi-Fi branded stores are typically relatively small and located in high-foot-traffic areas. The brand has resonated well among consumers as a differentiated youthful brand offering value and convenience. However, competitors have realigned their strategy to offer similar levels of discounts and store appeal. The demise of Dick Smith has removed a competitor, but we expect competition in electronics retailing to remain significant, especially from online pure plays like Amazon, Kogan, and Catch.

Online retailers operate in an environment of very low fixed operating costs, with technology providing a 24-hour shopfront and no need for expensive leases or sales staff. The lower operating cost enables digital retailers to deliver products at a compelling price and offset JB Hi-Fi's scale advantage. JB Hi-Fi’s offering is also not differentiated enough to justify selling products at a premium retail price. The company competes on a global stage in online, with the distinct disadvantage of corralling a domestic population of around 25 million, compared with those from the US, servicing more than 330 million.

We expect an increasing proportion of consumers will shift to online shopping and see this as a structural headwind for omnichannel retailers including JB Hi-Fi. Branded technology has become commoditized, and we see consumer electronics as one of the most exposed categories to channel shift. With online penetration of 35% in 2022, according to Euromonitor, we think e-commerce has significant headroom to take share in Australian consumer electronics based on higher penetration in comparable markets, such as the US around 72%, as per Euromonitor, the UK at 69%, and Germany at 42%. Amazon Australia will be a driving force underpinning digital migration. For instance, the mega warehouse under construction in Melbourne, mirroring its already operational Sydney automated fulfilment center, will add an estimated AUD 3 billion in sales capacity, or 9% of nongrocery e-commerce.

We estimate JB Hi-Fi lost share in consumer electronics retailing over the last decade due to online migration and expect this trend will continue. Adjusting for the acquisition of The Good Guys, JB Hi-Fi’s share of offline consumer electronics sales has remained broadly flat over the last decade, as per data from Euromonitor. However, e-commerce’s of electronic and appliance retailing has increased considerably, to around 35% in calendar 2022 from 11% in calendar 2012. Because JB Hi-Fi is underindexed to online, with fiscal 2024 penetration of 15% for JB Hi-Fi Australia, it has lost share of total consumer electronics retailing despite making some inroads in the offline channel. 

Do you own these shares? Should you sell immediately? Not so fast. Read our article on when to sell shares. 

Get free insights from Morningstar in your inbox