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Why Royal Bank of Scotland Group plc is a top ‘secret’ growth stock

Image: Royal Bank of Scotland. Fair Use.

This year has been a largely successful one for investors in RBS (LSE: RBS). The company’s share price has risen by over 20%, which means it has outperformed the FTSE 100 by around 17% at the same time as the index has reached record highs.

However, there is still some way to go until the bank returns to full financial health. Historic issues continue to hurt its overall performance, while investor sentiment remains held back by the uncertainty it faces. In the long run though, the company could be a top turnaround stock due to its potential for high growth in earnings.

Recovery prospects

As with any recovery stock, RBS has experienced a period of difficult financial performance. Its bottom line has remained generally in the red in recent years at the same time as many of its sector peers have posted improving levels of profitability. This is partly reflective of the scale of challenges the company faced during the financial crisis, and the impact they have continued to have even in recent years. Additionally, the strategy pursued by the company may not have been as successful at improving efficiencies or changing its risk profile, as has been the case elsewhere within the sector.

Looking ahead, RBS is forecast to return to impressive levels of profitability in the next two years. It is due to deliver a pre-tax profit of £2.9bn this year, followed by a rise of around 6% next year to £3.1bn. This puts the stock on a forward price-to-earnings (P/E) ratio of just 10.6, which suggests that it offers a wide margin of safety. This could mean its upside potential is high – especially since dividend growth prospects are also impressive. It is due to yield 3.3% next year from a shareholder payout which is expected to be covered 2.9 times by profit.

Turnaround potential

Of course, RBS is not the only stock with high growth potential. Reporting on Wednesday was aerospace and defence company Cobham (LSE: COB). It has released a number of profit warnings in the past, but trading in the current year has generally been as expected. The company is seeking to build the foundations for future growth through the resolution of onerous contracts, as well as concentrating on simplifying its business and improving the customer proposition.

Cobham’s future prospects are uncertain, given that it is in the process of attempting a major recovery process. However, it is expected to report a rise in its bottom line of 14% in the next financial year. This puts it on a price-to-earnings growth (PEG) ratio of just 1.5, which suggests that it could offer impressive capital growth potential.

While its share price and that of RBS may remain volatile and the two companies could have uncertain outlooks, they could also deliver surprisingly high levels of capital growth in the long run.

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Peter Stephens owns shares in RBS. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.