One growth stock I’d add and one I’d avoid in 2017

Bilaal Mohamed picks out one stock that could yield rich rewards and one that looks too expensive 2017.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Shares in the UK’s leading engineering support services provider Babcock International (LSE: BAB) have been on a downward trend ever since they soared to record highs of 1,417p almost three years ago. Investors could be forgiven for thinking that perhaps lower revenues or shrinking profits were to blame. Au contraire. The group has reported higher revenues and pre-tax profits in each of the three years since, and City forecasters are predicting a continuation of this trend.

Too cheap to miss

Sometimes the market can get over-enthusiastic about a company with good prospects, particularly one with a great track record of growth, such as Babcock. Investors can pile in and drive the share price higher until such time that they become overvalued, even after factoring-in a healthy outlook. Eventually the share price rally is over-extended, and a market correction follows. But after losing a third of their value, have Babcock’s shares become too cheap to miss?

In its most recent half-year report the FTSE 100 group boasted a 12% rise in pre-tax profits to £163.5m, helped by a 7% uplift in revenues to £2,173m from £2,039m a year earlier. Management celebrated with a 7% hike to the dividend, declaring an interim payout 6.50p per share.

Strong order book

The group’s order book also remains strong at £20bn, having been replenished by £2bn of contracted work during the first half of 2016/17. This should provide Babcock with strong visibility of future revenues in the short and medium term with 93% of revenue in place for the full year and 63% for FY 2018.

Analysts are forecasting high single-digit growth in earnings for the next three years, bringing the P/E ratio down to just 10 for the year to the end of March 2019. This compares favourably to the group’s five-year range of between 13 and 17. Furthermore, the steadily improving dividend yields 3% for the current year, rising to 3.4% by FY 2019. I think bargain hunters could do worse than add Babcock to their portfolios.

Appealing growth play

In contrast to Babcock, engineering distribution firm Electrocomponents (LSE: ECM) has seen its shares rocket over the past year, rising an astonishing 130% in the space of just 12 months. The Oxford-based group is the world’s leading high-service distributor for engineers, trading through its RS Components and Allied Electronics brands.

In its last trading update the company revealed a 45% leap in first half underlying pre-tax profits to £55.1m, with revenues up 12.7% to £706.3m, helped by foreign exchange tailwinds and extra trading days. Further earnings expansion looks set to continue, with analysts anticipating strong double-digit rates of growth over the next few years.

But at current levels the shares are trading on a very demanding 25 times forward earnings for the current financial year to March, with the dividend yield sinking to just 2.5%. Electrocomponents remains a very appealing growth play, but I think it would be prudent to wait for a better entry point.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Bilaal Mohamed has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

Down 8% in a month! The BP share price is screaming ‘buy, buy, buy’ at me right now 

When crude oil falls, the BP share price invariably follows. Harvey Jones is wondering whether this is the right point…

Read more »

Bus waiting in front of the London Stock Exchange on a sunny day.
Investing Articles

Could the 9.8% M&G dividend yield get even bigger?

Christopher Ruane reckons that, although the M&G dividend yield is already close to a double-digit percentage, it could get better…

Read more »

Investing Articles

How much passive income could I earn by putting £380 a month into a Stocks and Shares ISA?

Christopher Ruane explains how he'd aim to turn a Stocks and Shares ISA into four-figure passive income streams each year.

Read more »

Investor looking at stock graph on a tablet with their finger hovering over the Buy button
Investing Articles

2 passive income stocks I’m buying before an interest rate cut

With the market expecting interest rates to fall in August, time might be running out for investors looking to buy…

Read more »

Investing Articles

If I’d bought Rolls-Royce shares a year ago, here’s what I’d have now

Rolls-Royce shares have been the big FTSE 100 success story of the past 12 months and more. And there's still…

Read more »

Young female analyst working at her desk in the office
Investing Articles

If the Dow’s heading for 60,000 by 2030, can the FTSE 100 index hit 12,000?

Strategist Ed Yardeni predicts a 50% rise for America’s Dow Jones Industrial Average over six years. Can the FTSE 100…

Read more »

Investing Articles

Is the National Grid share price a once-in-a-decade opportunity?

The National Grid share price looks like a bargain. But there’s much more for investors to think about than a…

Read more »

Investing Articles

Here’s why the Rolls-Royce share price should keep gaining!

The Rolls-Royce share price is up 185% over the past 12 months, but there are a host of tailwinds that…

Read more »