Investing in companies with a track record of beating market expectations can be a profitable strategy. Today I’m looking at two companies which have both earned multiple broker upgrades over the last year. Does their recent performance justify a continued ‘buy’ rating?
At the top of the class
Shares of educational software specialist Tribal Group (LSE: TRB) rose by 6% on Thursday after it said it expected full-year profits to be “materially ahead” of expectations.
The company’s explanation for this performance was surprisingly straightforward. It says strong trading momentum means that sales should be “slightly ahead of expectations”. But the firm’s 2016 reorganisation has resulted in “effective cost control” and “a balanced improvement across all lines of business”.
Use of the word “materially” usually means at least 10%. So using this as a guide, I expect consensus forecasts for earnings of 2.6p per share to be upgraded to perhaps 2.9p. That would put the stock on a forecast P/E of 30 for the current year.
Although this isn’t cheap, broker forecasts for next year already suggest that earnings could climb by another 30% or so to 3.4p per share. If this kind of growth is sustainable, then the shares could still have a lot further to go.
What could go wrong?
I think it’s worth noting that Tribal’s 2016 reorganisation was made necessary by heavy losses in 2014 and 2015. The company may still be in a turnaround phase. Earnings growth may well slow at some point.
However, today’s guidance implies that profit margins are rising and confirms that the group expects to end the year with an increased cash balance. If I was a shareholder, I’d feel confident holding this stock, and might consider topping up on any market wobbles.
22% increase in orders
When a company’s order intake rises by 22% in one year, it may be worth paying attention.
That’s what happened last year at Avon Rubber (LSE: AVON). This 127-year old business has two arms. It’s makes high-tech gas masks for the defence, industrial and fire service markets, and it produces milking systems for dairy farmers.
Despite the apparently niche nature of these activities, growth has been very strong in recent years. Sales have risen from £107m in 2012 to £163m last year, while the group’s profits have risen from £7.8m to £21.5m over the same period. That’s equivalent to average sales growth of 9% per year and profit growth of 22% per year.
Why I’d buy
When profits rise faster than sales, this usually indicates that profit margins are rising. That’s mostly been the case at Avon, which also benefits from having a debt-free balance sheet.
The group’s shares have risen by 70% over the last three years, but strong earnings growth means they don’t look overly expensive to me, with a forecast P/E of 17.6.
One reason for this fairly average rating might be that earnings growth is expected to be less than 5% per year over the next couple of years. Another downside is that the dividend yield is fairly modest, at just 1.3%.
However, I view this as a quality long-term investment, capable of delivering reliable growth over decades. Looked at in this way, I believe the shares offer decent value and could be worth buying at current levels.
