With the FTSE 100 Index trading at nearly 18 times forward earnings, you may be finding it harder and harder to find growth stocks for a reasonable price. Fortunately, I have found two growth stocks with forward P/Es of less than 10, which are surely worth a closer look.
Good growth potential
At first glance, outsourcing group Capita (LSE: CPI) seems incredibly cheap. The stock trades at a P/E of just 8.0 and has a price-to-sales (P/S) ratio of 0.8. But are these valuation metrics deceptive in light of the group’s recent profit warning?
Back in September, Capita warned that its pre-tax profit may fall short of its earlier estimates following delays to its contract with the Transport for London (TfL), which is expected to cost the company a one-off charge of between £20m and £25m. It now expects to deliver underlying pre-tax profits in the range of £535m to £555m, which is up to 15% below its earlier projections of £614m.
Shares in the company have since fallen by about 42%, but have investors overreacted? Captia’s earnings will certainty hit a bump this year, but the company is expected to return to growth thereafter. The company maintains good growth potential and is not being complacent. It has won £949m worth of new contracts so far this year, and has announced plans to simplify its organisational and management structure.
Capita said the revamped structure would “provide greater management strength and depth across all of Capita’s operations” and “provide a deeper sales and business development focus and greater support in driving organic growth“.
City analysts have lowered their expectations for earnings in recent weeks, but earnings forecasts are still pointing towards a modest rebound for the following year. Underlying EPS is expected to fall by 7% this year, but increase by 4% in 2017. This means its forward P/E is expected to fall to 8.4 in 2017, from 8.7 forecast for this year.
And despite its recent troubles, the company is expected to maintain its progressive dividend policy. That’s because even as earnings is projected to fall this year, earnings is set to cover its dividends by more than two times. Investors should, therefore, have little to worry about the sustainability of Capita’s 5.6% dividend yield.
Lagged the market
Another growth stock looking too cheap to ignore is specialist lender OneSavings Bank (LSE: OSB). The stock was one of the top performers in the sector back in 2014 and 2015, but it has since lagged the market, after having fallen by more than 12% year-to-date.
But with city analysts expecting the bank to deliver earnings growth of 14% and 3% for 2016 and 2017, respectively, I reckon the stock is oversold. Based on these estimates, OneSavings Bank is valued at 7.1 times expected earnings this year, and 6.9 times its earnings in 2017.
There are downside risks though. The bank is heavily exposed to the buy-to-let mortgage sector, which is highly cyclical and more vulnerable to interest rate hikes. The economy, which has proved to be more resilient than expected in recent months, is expected to slow in the coming months and this could potentially lead to slowing demand for new mortgages and rising loan impairments.
