Finding the market’s best growth stocks is never an easy task. Separating the wheat from the chaff is the hardest part as while there are many stocks out there that look like they have all the hallmarks of a top growth pick, more often than not, the story ends in tears.
However, there’s one small-cap growth stock that I’ve recently discovered that looks as if it could be one of the market’s best growth stocks.
The name of the company in question is Franchise Brands (LSE: FRAN), and over the past 12 months, shares in the group have risen by 112% excluding dividends as the market has started to realise the opportunity here.
Over the past two years, Fran’s growth has stagnated as management has struggled to drive growth organically, but this has now changed thanks to the £20m acquisition of Metro Rod, a leading provider of drain clearance and maintenance services. With Metro now part of the business, City analysts expect the company to report a pre-tax profit of £2.4m for 2017 with earnings per share growing 13% to 2.7p. Revenue for the year is set to leap from £5m to £25m.
And as Fran increases Metro’s offering, further growth is expected in the years ahead. For example, City analysts have pencilled-in earnings per share growth of 44% to 3.9p for 2018 on a pre-tax profit of £3.9m and revenue of £38m.
Robust balance sheet
Explosive earnings growth is complemented by the firm’s strong balance sheet. For the year to 31 December 2016, it generated £1.1m in cash from operations and ended the year with a cash balance of £3m. The Metro acquisition was funded with a £20m share placing as well as a £17m debt facility. In total, Metro cost Fran £28m indicating that after the buy closed, the company would be indebted to the tune of £5m. With pre-tax profits of £6.3m projected for the next two years, this debt appears sustainable.
So earnings growth is explosive, the company’s balance sheet is strong, and management seems set on creating value for shareholders. But there is one problem, and that’s valuation.
At the time of writing shares in Fran are trading at a forward P/E of 34.6, which looks expensive even considering the earnings growth projected for 2017. Still, if the company can hit City targets for growth this year, next year the valuation will fall to more appropriate levels.
Based on 2018 earnings estimates the shares are trading at a forward P/E multiple of 23.9 compared to projected earnings per share growth of 44%. On this basis, the shares trade at a PEG ratio of 0.5. A PEG ratio of 0.5 indicates that the stock in question offers growth at a reasonable price.
The bottom line
Overall, this firm seems to have it all, and if the company can grow earnings as expected over the next two years, the shares still look cheap at current levels.