2 dividend-growth stocks that could beat the FTSE 100

Roland Head highlights two mid-cap stocks that could steam ahead of the FTSE 100 (INDEXFTSE:UKX).

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If you’d invested £10,000 in the FTSE 100 in February 2013, it would be worth £11,762 today, despite this week’s correction. However, £10,000 invested in the mid-cap FTSE 250 index five years ago would be worth £14,723 today.

The smaller companies in the FTSE 250 have collectively outperformed their larger rivals in the big cap FTSE 100. Some individual stocks have done even better. Today I’m looking at two FTSE 250 stocks I believe could beat the market over the next few years.

Can this turnaround deliver?

Defence specialist QinetiQ Group (LSE: QQ) has fallen out of favour with the market over the last year. But I’m starting to think that this sell-off may have gone too far.

A trading update today confirmed expectations for the current year. Broker forecasts were upgraded in November following the group’s interim results, so it’s encouraging to get confirmation that management expects to hit these increased profit figures.

One potential concern is that earnings are expected to be broadly flat next year. The company is in the middle of a programme aimed at reducing its dependency on UK government work and developing a more international client base.

During the first half of the current year, revenue generated from outside the UK increased from 21% to 26%, suggesting progress. The group said today that while the UK remains “challenging”, it’s seeing good growth in Australia and the Middle East.

Risk versus reward

It’s not yet clear to me when QinetiQ’s business will return to growth. But the group benefits from net cash of nearly £200m and an attractively high operating margin of 18%. In my view, these strengths should provide the time and support needed for its turnaround.

For investors, I think the forecast P/E of 12 and prospective yield of 3.3% could be a profitable level to buy. I’ve added this stock to my own watch list.

A proven top performer

If you’re uncomfortable about the situation at QinetiQ, then you may prefer to consider proven growth stock Electrocomponents (LSE: ECM) for your portfolio.

This electronic component distributor operates in 80 countries and ships more than 50,000 parcels a day from a range of more than 500,000 products. Engineers in Europe will recognise the company’s RS Components brand, while in America it operates as Allied Electronics and Automation.

Business has been booming in recent years and underlying revenue rose by 13.3% during the first half of the current year. This momentum appears to have been maintained into the second half, as sales rose by a further 14% during the four months to 31 January.

Non-stop broker upgrades

Brokers’ consensus forecasts for this year’s earnings have risen in 10 out of the last 12 months. The group is now expected to report adjusted earnings of 27.1p per share this year, up from an estimate of 21.9p one year ago.

Core financial metrics are equally impressive. Return on capital employed is running at nearly 20%, and the dividend should be covered comfortably by free cash flow this year. Adjusted earnings are expected to rise by 29% this year, and by a further 13% next year.

Although the shares may look pricey on a 2018/19 forecast P/E of 20, I believe this firm’s strong growth and financial quality suggests the stock could continue to perform well.

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 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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