One FTSE SmallCap Index growth stock I’d buy, and one I’d sell

G A Chester’s calls on these two FTSE SmallCap Index (INDEXFTSE:SMX) growth stocks could be controversial.

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Engineer Goodwin (LSE: GDWN) and nearly-new car dealer Motorpoint (LSE: MOTR) are constituents of the FTSE SmallCap Index. Both rank towards the lower end, with market caps of £150m and £220m, respectively.

I believe one of these stocks currently offers excellent value and I rate it a ‘buy’. I see the other as having hidden risks that lead me to give it a place on my ‘sell’ list.

Re-rating potential

Formerly a growth stock for a good number of years, Goodwin’s annual earnings advances ground to a halt — nay, went into reverse — in the wake of the oil and metals prices crash. The company said in its recent half-year results that while oil has recovered to over $60 a barrel and iron ore to over $60 a tonne, “there is little reason to expect an upturn in the release of orders for new capacity in these capital equipment-needy markets until 2020.”

However, Goodwin hasn’t been idle in winning business in new markets, such as nuclear recycling and decommissioning, while its refractory engineering business is also growing. Established in the nineteenth century and still run by descendents of the founders, the company is prudently managed to be resilient through cyclical downturns. It’s remained profitable and maintained its dividend during the recent challenging period. Net debt remains relatively conservative at £27m, particularly as we’re at the bottom of a cyclical trough.

A trailing 12-month earnings multiple of 23 may not appear particularly good value but investors are beginning to recognise that the company is returning to growth. A measure of the potential re-rating over the next few years is that the current share price represents less than eight times previous peak earnings. For these reasons, I rate the stock a ‘buy’.

Downside risk

On the face of it, Motorpoint’s trailing 12-month earnings multiple of 13.8 appears reasonable value and its balance sheet solid, with £21.4m cash and no debt. However, I have several concerns that persuade me to rate the stock a ‘sell’.

Car sales have boomed in the easy credit environment since the financial crisis. The numbers and proportion sold via financing deals have risen mind-bogglingly. And of course, companies involved in flogging cars have seen terrific increases in their profits.

From time to time you get a spate of stock market flotations in a particularly ‘hot’ sector that often turn out to be at or near a cyclical high. Motorpoint’s flotation last year followed those of Auto Trader and BCA Marketplace (owner of WeBuyAnyCar) the year before. However, this year, new car sales have fallen off a cliff and sales of second-hand vehicles dipped for a second successive quarter in July-September.

As well as being exposed to the general state of the economy, Motorpoint relies on various finance facilities to fund its operations, including stock financing secured against its retail vehicle stocks. It concedes that a change in pricing, facility limits etc “could significantly constrain the Group’s ability to trade or the Group could be required to dispose of assets at below their market value or at a substantial discount.”

The company had £90m of inventory at its latest balance sheet date, as well as other assets that could be adversely impacted by falling sales and prices. I see risk of a significant downturn, which isn’t discounted in the current share price.

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.

G A Chester has no position in any of the shares mentioned. The Motley Fool UK has recommended Goodwin. 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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