2 under-the-radar income stocks that should beat the FTSE 100

Roland Head explains why he expects these mid-cap stocks to continue beating the FTSE 100 (INDEXFTSE:UKX).

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Today I’m going to take a closer look at two mid-cap stocks I believe have the potential to beat the FTSE 100 over the next few years. Both companies offer an attractive mix of growth and income, and have recently reported strong trading.

Impressive growth

Mid-range hotel operator PPHE Hotel Group (LSE: PPH) operates the Park Plaza, art’otel and Arena hotel brands. In total the group has 39 hotels in Europe, the Middle East and Africa.

Business appears to be good. Like-for-like revenue has risen by 13.1% to £232m during the nine months to 30 September. Revenue per available room (RevPAR) has risen by 12.2% to £91.7 over the period, helped by a 2.7% increase in occupancy to 76.7%.

The fourth quarter is usually the strongest period of the year, excluding Croatia, and management says it’s confident of meeting full-year expectations.

Why I’d buy

PPHE Hotel’s shares don’t seem especially expensive to me. The stock currently trades at 1.1 times its book value of 986p, on a 2017 forecast P/E of 16. A dividend yield of 2.2%, covered three times by earnings, is expected this year.

Although this valuation may not seem cheap, the company is delivering steady growth and is expected to report a 20% increase in earnings per share next year.

In addition to operating hotels that it owns, the group is also making use of lease and franchise opportunities to deliver faster growth and reduce capital expenditure. This is a strategy that’s been pursued very successfully by some other groups, notably FTSE 100 firm InterContinental Hotels.

PPHE has outperformed the FTSE 100 by 43% over the last year. I believe there could be more to come.

Long-term growth

Another company that’s outperformed the FTSE this year is Morgan Advanced Materials (LSE: MGAM). This company uses ceramics, carbon and composite to make a wide range of products, including insulators, technical ceramics and equipment for foundries.

After several years of flat performance, the outlook appears to be improving. The group’s return on capital employed (ROCE) — an important measure of profitability — rose from 11.8% to 16.4% last year.

A high ROCE is generally attractive to investors, as it increases a company’s ability to fund its own growth without needing to borrow cash. A figure of more than 15% is generally considered to be very good.

Morgan appears to be taking advantage of this growing profitability by increasing spending on research and development. This should help to build the foundations needed for new product ranges and long-term growth.

Another attraction for shareholders is that a high ROCE also tends to correspond with strong free cash flow generation, which supports dividend payments.

Is the price right?

Morgan Advanced Materials currently trades on a 2017 forecast P/E of 14.5, with a prospective yield of 3.5%. These figures seem reasonable to me for a growing business.

If the company can deliver the expected double-digit earnings growth next year, I’d expect the shares to continue performing well. In the meantime, the dividend yield of 3.5% is higher than the FTSE 250 average of 2.7%, providing a worthwhile income.

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.

Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Morgan Advanced Materials. 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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