Investing in a FTSE 100 tracker may be a safe way to build wealth. But I believe that putting all of your cash into a tracker fund risks missing out on a lot of potential profit.
Today I’m looking at two FTSE 250 stocks that I believe could power ahead of the FTSE 100 over the coming years.
A turnaround in progress
Back in January, I tipped defence firm Chemring Group (LSE: CHG) as a potential buy. The shares rose by about 30% after that, until a serious fire at its Countermeasures factory in Salisbury caused the shares to crash in mid-August.
The group’s shares fell from 236p to under 195p following this incident, in which one person was killed and one seriously injured. However, Chemring shares have risen by more than 10% already this week, after the firm announced a major new contract win and issued an update on trading.
Work is going to gradually restart at the Salisbury factory, starting with shipments of finished orders. As the factory is rebuilt, it’s likely to be more heavily automated than it was previously. I’d expect this to result in higher profit margins over the long term.
In the meantime, Chemring has won a long-term contract to supply chemical agent detectors to the US Department of Defense. The company says this is the result of several years’ research and development. No information was provided about the value of the deal, but it was enough to send the shares up by 5%. This suggests to me that it’s expected to make a meaningful contribution to future profits.
A buying opportunity?
The fire is expected to cut Chemring’s underlying operating profit by about £15m this year. Aside from this, management says that trading is in line with expectations.
Analysts’ forecasts are for earnings per share to drop by around 18% in 2018, before bouncing back next year. This puts the stock on a 2018 forecast P/E of 20, falling to a P/E of 16 in 2019. The group’s dividend yield is expected to rise from 1.6% in 2018 to 2% in 2019, as profits and cash flow improve.
I believe Chemring could be a good buy at this level, for long-term investors.
A safer option?
If you’re concerned about investing in a firm that’s facing significant operational disruption, you might want to consider my second choice. FTSE 250 engineer Vesuvius (LSE: VSVS) specialises in “molten metal flow engineering”.
This company makes equipment used in foundries and in the steel industry. The group’s shares have risen by 11% over the last year, compared to a gain of just 2% for the FTSE 100. Although profits dipped in 2015 and 2016, last year saw Vesuvius return to profit growth.
Further progress is expected this year. Analysts expect adjusted earnings to rise by about 15% to 47p per share in 2018. A dividend of 19.3p per share is expected, an increase of 7.2% versus last year’s distribution.
These forecasts put Vesuvius on an undemanding forecast P/E of 13.4, with a prospective dividend yield of 3.1%. In my view this could be a good example of a boring business that makes a good long-term investment. I’d consider buying this stock at current levels.