Legendary fund manager Jim Slater once said that elephants don’t gallop. He was explaining why he preferred to invest in smaller companies that still have plenty of scope for growth.
It’s certainly true that the FTSE 250 index of mid-sized companies has outperformed the big-cap FTSE 100 consistently since 2003. Over the last five years alone, the FTSE 250 has gained 17%, compared to a 5% rise for the FTSE 100.
A growing part of my own portfolio is invested in FTSE 250 stocks. Today I want to look at two companies from my watch list.
A top sector buy?
Housebuilder Redrow (LSE: RDW) reported a record half-year profit of £185m this morning, ahead of the retirement of its founder Steve Morgan.
Chairman Mr Morgan has retired once before, but returned to rebuild the business in the wake of the financial crisis. I suspect this departure will be final, but today’s figures suggest he will be leaving behind a business that’s performing well despite Brexit fears.
Legal completions rose by 12% to 2,970 homes during the six months to 31 December, while Redrow’s revenue climbed 9% to £970m. The company’s return on capital employed, a key measure of profitability, rose from 25% to 28%.
A 10% dividend yield
Net cash reached £101m by the end of the year, up from £63m in June. This surplus cash is set to be returned to shareholders via a one-off cash return of 30p per share, representing a total payout of £111m.
Shareholders will also receive a regular interim dividend of 10p, putting the firm on track for a full-year forecast dividend of 29.8p per share.
These two payouts together mean that Redrow stock looks likely to yield 10% this year, at the current share price of c.600p.
Can this continue? The outlook for the housing market is hard to call. However, the group’s £1.2bn order book suggests good visibility for the current year. With the shares trading on less than seven times forecast earnings, I think Redrow remains one of the best choices in the housing sector.
A global alternative
If you’re unsure about investing in companies that only operate in the UK, automotive group Inchcape (LSE: INCH) might be of interest. You may know the name for its UK dealership and leasing business. However, this is only a relatively small part of Inchcape’s global business as a distributor for a number of major brands.
Distributors act as a manufacturer’s representative in a country. They contribute to localisation of new models, logistics and production planning. They also manage the dealer network in their territory.
About 90% of Inchcape’s profits come from distribution, through operations in Asia, Australia, Central America, the UK and Europe. Only 10% of profits come from retailing cars.
In my view, the wide geographic reach of this business should mean that it’s less exposed to cyclical downturns than traditional dealership groups. A regional downturn in one market shouldn’t affect the group’s performance in other regions.
Inchcape shares have fallen by 30% from last year’s high of 826p. The stock now trades on 9.3 times forecast earnings and offers a well-covered 4.6% dividend yield. I believe this could be a good time to buy.
