One of the easiest ways to build a market-beating portfolio is to focus your investment cash on companies with high profit margins and sustainable growth.
Legendary billionaire investor Warren Buffett is also a fan of this approach. He once said that “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
Today, I want to look at two UK stocks which I think have the potential to deliver above-average profits over long periods.
A success story
The share price of small-cap asset manager Miton Group (LSE: MGR) rose by 6% this morning, after reporting a 52% rise in pre-tax profit for the six months to 30 June.
Assets under management rose by 35% to £4,539m during the half-year. Adjusted pre-tax profit was £4.4m, up 52% from £2.9m during the same period last year. The group ended the period with net cash of £21m.
This AIM-listed fund manager built its reputation as a small-cap specialist under the direction of fund manager Gervais Williams. Miton is now starting to diversify, but the group’s investment performance remains strong.
The company has now recorded seven consecutive quarters of net inflows of new client cash. And 91% of its funds have been in the top 50% of rivals since they were launched, or since the current fund manager took charge.
Too late to buy?
One risk for shareholders is that fee income could fall sharply in a market correction. Another is that the firm’s small-cap focus may be hard to scale.
However, I rate Miton as one of the best firms in this sector. I’m also reassured by the net cash balance, which provides about six years’ cover for the dividend.
The stock now trades on 17 times forecast earnings with a 2.5% yield. That’s no longer cheap, but I’m happy to continue holding.
This dip could be a buying opportunity
Another financial stock I rate highly is FTSE 250 online trading firm IG Group Holdings (LSE: IGG). The IG share price dropped 10% last week after the firm revealed a 5% drop in revenue during the three months to 31 August.
This fall was caused by new European regulations, which limit the amount of leverage the firm can offer to retail traders. IG shares have now fallen by nearly 20% from their July peak. But in reality, last week’s update didn’t contain any surprises. The group simply confirmed its expectation that annual revenue could fall by up to 10% as a result of the new rules.
A profit margin of nearly 50%
It’s too soon to be certain of the impact that the new EU rules will have on IG’s profits. But more than 50% of the group’s UK and EU revenue is now generated by clients classified as professional, who are exempt from the new rules.
The group generated an operating margin of 47% last year and has a long track record of high profit margins and strong cash generation. In my view, this year’s expected 15% fall in earnings is now reflected in the share price.
At about 765p, IG stock trades on a forward price/earnings ratio of 15, with a prospective yield of 5.4%. Profits are expected to return to growth in 2019. I rate the shares as a buy at this level and have added the stock to my watch list.
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Roland Head owns shares of Miton Group. 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.