Investors are often on the lookout for the next big thing. But when it comes to picking stocks, the most profitable investments may be those which are already doing well.
If you buy quality businesses at sensible valuations, history suggests that they will often continue to deliver rising profits and attractive returns.
Still climbing
Back in March, I chose plastic piping firm Polypipe Group (LSE: PLP) as my top stock for the month. The shares have since risen by 18%. Polypipe published its half-year results this morning, giving me a chance to review the firm’s progress.
First impressions are fairly good. Sales rose by 8.4% to £242m during the six months to 30 June, while operating profit rose by 2.8% to £34.9m. Obviously it’s good news that sales and profits are rising. But because sales rose by more than profits, we can see that the group’s profit margins were lower than during the same period last year.
Crunching the numbers tells me that Polypipe’s operating margin fell from 15.2% to 14.4% during the first half. That’s still an impressive figure, but why has it fallen?
The problem seems to be that raw material costs have risen. The company is passing these increases on to customers through higher price, but this is taking some time. This is a common problem for manufacturers. I’m not too concerned, as the issue seems to be well under control.
The board expects trading to improve during the second half of the year and is confident of hitting full-year expectations. Based on the latest broker consensus forecasts, this puts the stock on a forecast P/E of 15, with a prospective yield of 2.7%.
That seems a fair valuation, but Polypipe’s disciplined management and track record of growth suggest to me that further gains may be likely. I’d be happy to buy or hold at current levels.
This newcomer has done well
If you’re nervous about investing in housebuilders but would like some exposure to the UK housing market, one option might be Ibstock (LSE: IBST). This £1bn company makes bricks and other concrete building products.
Ibstock shares have risen by 25% since the firm’s flotation in October 2015. This puts it ahead of the FTSE 250, which has risen by 15% over the same period.
I’m attracted by this company’s high profit margins. Ibstock generated a return on capital employed (ROCE) of 19% last year. That’s quite high and suggests to me that the group has the potential to generate a lot of surplus cash to fund growth and dividends.
Ibstock is due to report its half-year results on 10 August. Analysts are expecting another strong performance. Earnings per share are expected to rise by 15% to 18.7p in 2017, putting the stock on a forecast P/E of 13. The dividend payout is expected to rise by 9%, giving a potential yield of 3.4%.
This business appears to be firing on all cylinders and is growing steadily. But producing bricks is a cyclical business. Any reduction in housebuilding activity could leave the firm with surplus capacity, or force it to cut prices. In either case, profits would slump.
Despite this risk, the outlook seems strong at the moment. I’d continue to hold.
