One super growth stock I’d buy before IQE plc

Roland Head explains his target price for IQE plc (LON:IQE) and reviews another top performer.

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Fashion retailer Superdry (LSE: SDRY) has changed its name but not its performance. Sales at the company formerly known as Supergroup rose by 20.4% to £402m during the six months to 28 October. Underlying pre-tax profit was 20% higher at £25.3m.

Underlying earnings per share climbed 22.8% to 25.8p, while the interim dividend was lifted 19% to 9.3p.

Can this company continue to generate the kind of sales growth needed to drive the shares higher?

Two giant opportunities

One advantage Superdry has over some UK high street rivals is the global appeal of its brand. The firm’s fashion is already sold in 148 countries. However, until quite recently there have been two big names missing from the list — the USA and China.

The company is now working to put this right and has begun a “disciplined roll-out” in these two giant-sized markets. I believe that similar success in these two markets to that achieved elsewhere could have a big impact on profits.

Analysts certainly expect further strong earnings growth. Earnings per share are expected to rise by 16% to 96p this year and by a further 17% to 112p in 2018/19. These forecasts leave the stock on a forecast P/E of 21, falling to a P/E of 18 next year.

This may seem expensive, but in my view it’s worth remembering that this business typically generates payback on new stores in just two years. I believe the shares could still represent good value at current levels.

Where next for this triple-bagger?

I’m less confident about triple-bagging tech stock IQE (LSE: IQE), which supplies “advanced wafer products and wafer services to the semiconductor industry”. Although this firm’s shares are still worth three times as much as they were one year ago, they’ve fallen by nearly 25% since mid-November.

I suspect this is a sign that savvy investors are taking profits, believing — as I do — that IQE’s valuation has run ahead of itself.

That doesn’t mean the growth potential here isn’t real and impressive. I think it could be.

For example, in December IQE reported that sales of its Photonics products were expected to have doubled in 2017. The firm believes it has a “sustainable lead in this market” thanks to its intellectual property and its ability to scale this complex technology.

Key risks

My concern is that investors in this Cardiff-based firm face some risks that aren’t reflected in the current share price. For example, the 2016 annual report shows that 45% of sales come from two customers. The loss of a major customer can be devastating for companies like IQE, as we saw with Apple supplier Imagination Technologies last year.

A second risk is that the company has spent heavily on expansion in expectation of future growth. This is necessary, but I suspect it means that the firm currently has costly surplus capacity.

With the shares trading on a 2017 forecast P/E of 42 and a 2018 forecast P/E of 31, I think a lot of good news is already in the price.

Although the stock’s PEG ratio of 1.2 is fairly low, I think the shares could have further to fall before finding support. Personally, I’d put a buy price on this stock of around 100p-110p.

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 owns shares of and has recommended Apple. The Motley Fool UK owns shares of Imagination Technologies and has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool UK has recommended Superdry. 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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