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Why I’d avoid this double-bagger and buy Premier Oil plc

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Today I’m going to look at two stocks which are at opposite ends of the value spectrum. One has delivered a 150% gain for investors over the last five years. The other has delivered an 85% loss over the same period.

On the face of it, the old City saying that you should run your winners and cut your losses seems appropriate. Why change something that’s obviously working well?

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For long-term shareholders of my high-flying stock, life sciences firm Abcam (LSE: ABC), it probably makes sense to sit tight and continue collecting your dividends.

But for new investors, I think it’s important to look ahead and consider how much upside is on offer. Abcam published its full-year results for 2016/17 today. The group’s sales rose by 26.5% to £217.1m last year, although this increase would have been just 9.9% without favourable exchange rate movements.

Pre-tax profit rose by 14% to £51.9m, while the group’s adjusted earnings per share rose by 13.9% to 25.5p. The dividend rose in line with adjusted earnings, up by 14% to 10.18p per share.

The group reported good growth across its main activities and says it continues to gain market share globally. Cash generation remained strong and the group ended the year with net cash of £84.8m, up from £70.7m last year.

What could go wrong?

I believe this is a good company, but I do have a couple of concerns which might prevent me investing at the moment.

The first is that Abcam’s profit margins have been falling gradually for years. Operating margin fell from 27% to 25.4% last year. Back in 2011, the firm reported an operating margin of 38%. Buying into a business with falling profit margins concerns me when the stock is expensive.

And it is expensive. Based on today’s figures, the shares trade on a P/E of 42. This high valuation means that the dividend yield is just 1%. Although earnings growth is expected to be 20%+ in 2017/18, I’m not convinced that the shares are cheap enough to give me a good chance of enjoying market-beating gains.

This stock could double

I prefer to invest in stocks which are out of favour but where trading is improving. One company that may fit this description is mid-cap oil and gas independent Premier Oil (LSE: PMO).

The company has recently completed a major refinancing. Net debt remains very high, at $2.7bn. But the group’s spending commitments and costs have fallen sharply and its cash flow should soon improve as newly-completed projects start production.

The opportunity for investors is that the equity market is still rightly nervous of the risks attached to Premier’s sky-high debt levels. The group is expected to generate a profit of $128m in 2018, but the shares trade on a 2018 forecast P/E of less than 4.

I’ve stayed away from Premier for a long time. But the firm’s recent results saw cash flow from operations of $292m, up from $109m during the first half of last year. This generated free cash flow of $178m, allowing the firm to reduce net debt by around $100m.

If debt reduction continues to plan and Premier returns to profit, I believe the shares could easily double. It’s not without risk, but I think this stock could now be a worthwhile recovery buy.

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Roland Head has no position in any of the 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.

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