An incredibly cheap growth and dividend stock to consider now

Decent growth and income priced to go. Should I fill my boots?

| 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.

Normally, when I see City analysts predicting forward earnings growth of 16% I don’t expect to see the forward price-to-earnings ratio of a company to be as low as nine.

However, that’s what we are seeing with RM (LSE: RM) right now, so is something wrong or is this share a bargain?

In line with expectations

The company provides educational resources, IT services and software to the education sector, and updated the market on progress on 22 March. Trading in the current year is down more than expected, according to the firm’s chairman John Poulter. Schools are being cautious with expenditure due to uncertainty over their funding and because staff costs rose this year, he reckons. One bright spot is that first-quarter trading in RM’s international business “continues its positive trend.”

Overall, the directors think full-year trading will come in as expected, which means a flat result on earnings for the year to November 2017 and 16% growth the year after that. Last year, around 20% of revenue came from outside the UK. So even though international trading is going well, I don’t think the 80% of trade coming from the UK can be dragging too hard on the firm’s results. Otherwise, City analysts’ forecasts would be bleaker. Meanwhile, the forecast growth in earnings for 2018 suggests the directors expect UK trading to bounce back.

So, a soft patch of trading in the UK this year and a positive outlook beyond that does not explain the low valuation. Even the forward dividend yield looks attractive running at just under 3.8% for 2018, with the anticipated payout covered three times by forward earnings – a high-looking level of cover suggesting the directors see opportunities to reinvest cash inflow for growth from here. Indeed, they expressed their confidence in RM’s future by hiking the final dividend for 2016 by more than 20% compared to the year before.

The elephant in the room?

There must be something wrong, and there is. It seems that the cash the firm generates from operations is all being gobbled up by the pension deficit. However, if that’s the issue holding the shares back, it could be disguising opportunity for investors.

With the full-year results for 2016, RM said the pension deficit increased “to £34.8m (2015: £21.9m) as liabilities have been impacted by lower market discount rates.” Of the just over £13m of cash from operations RM generated during the year, almost £12m went as a cash contribution to the defined benefit pension scheme. That’s a 200% increase over the £4m or so the firm threw at the pension the year before.

Nevertheless, RM is trading well, generating lots of cash, and ended 2016 with zero debt and a £40m cash pile on its balance sheet. The shares seem to be trending up and there’s no sign that the directors are scaling back their organic and acquisitive growth ambitions. RM could be well worth your further research. I think the low valuation compensates for the pension issue and a valuation re-rating could power investor returns from here as 2017 unfolds, as long as funding holds up in the education market.

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.

Kevin Godbold has no position in any shares mentioned. 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.

More on Investing Articles

Two white male workmen working on site at an oil rig
Investing Articles

Shell hints at UK exit: will the BP share price take a hit?

I’m checking the pulse of the BP share price after UK markets reeled recently at the mere thought of FTSE…

Read more »

Investing Articles

Why I’m confident Tesco shares can provide a reliable income for investors

This FTSE 100 stalwart generated £2bn of surplus cash last year. Roland Head thinks Tesco shares look like a solid…

Read more »

Smart young brown businesswoman working from home on a laptop
Investing Articles

£20,000 in savings? I’d buy 532 shares of this FTSE 100 stock to aim for a £10,100 second income

Stephen Wright thinks an unusually high dividend yield means Unilever shares could be a great opportunity for investors looking to…

Read more »

Investing Articles

Everyone’s talking about AI again! Which FTSE 100 shares can I buy for exposure?

Our writer highlights a number of FTSE 100 stocks that offer different ways of investing in the artificial intelligence revolution.

Read more »

The flag of the United States of America flying in front of the Capitol building
Investing Articles

3 top US dividend stocks for value investors to consider in 2024

I’m searching far and wide to find the best dividend stocks that money can buy. Do the Americans have more…

Read more »

Investing Articles

1 FTSE dividend stock I’d put 100% of my money into for passive income!

If I could invest in just one stock to generate a regular passive income stream, I'd choose this FTSE 100…

Read more »

Young mixed-race woman jumping for joy in a park with confetti falling around her
Investing Articles

Forecasts are down, but I see a bright future for FTSE 100 dividend stocks

Cash forecasts for UK dividend stocks are falling... time to panic! Actually, no. I reckon the future has never looked…

Read more »

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

Down 13% in April, AIM stock YouGov now looks like a top-notch bargain

YouGov is an AIM stock that has fallen into potential bargain territory. Its vast quantity of data sets it up…

Read more »