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This UK growth stock has soared in value. I think there could be more to come!

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As an example of just how rewarding the simple strategy of buying and holding great UK growth stocks can be, take the case of video game publisher Frontier Developments (LSE: FDEV). Five years ago, shares in the business were trading a little over the 200p mark. They were valued at 3270p each when the market shut yesterday.

Based on today’s interim results, I think further gains lie ahead.

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Lockdown winner

No doubt about it – 2020 was a great year for Frontier. As one might expect, the number of people buying and playing its games rocketed due to lockdowns and coronavirus-related restrictions. Sales of Jurassic World Evolution and Elite Dangerous, for example, both passed the 4m sales mark.

This, or course, has had a hugely positive impact on Frontier’s top line. Revenue for the six months to the end of November came in at £36.9m — a 15% improvement on the £32m achieved over the same period in 2019.

Assuming all goes well, Frontier believes full-year revenue will come in somewhere between £90m and £95m. I think there are several reasons to be optimistic this target will be hit. 

Reasons to be bullish

For one, all of £1.3bn-cap’s titles have continued to attract players since the end of the reporting period, at least according to the company. Revenue in December — traditionally the best month for video game sales — was “stronger than expected,” Frontier said today. The release of new title Elite Dangerous: Odyssey before the end of the financial year should help boost revenue further.

The recent news on Xbox sales from Microsoft also bodes extremely well and is further evidence, in my view, that video gaming and esports could be one of the investment themes of the decade.

Aside from its growing portfolio, Frontier also looks to be in rude financial health. The company had almost £35m in net cash at the end of November. 

This isn’t to say, however, investing now in this great UK growth stock isn’t without risk. 

What are the risks?

One potential snag is the possibility of new games being delayed by the pandemic. On this, Frontier already has form. Last month, the company announced the Playstation and Xbox versions of Elite Dangerous: Odyssey wouldn’t now arrive until FY22. While understandable given the challenges of remote working, there’s a chance the share price could take a knock if further delays are announced.

Aside from this, there are a few more general risks to consider. These include the possibility new game releases, just like ‘blockbuster’ movies, may flop. A loosening of lockdown restrictions could also see more players temporarily putting down their controllers to escape outdoors.

Lastly, there’s the frothy valuation. Changing hands for a whopping 72 times forecast earnings before markets opened, it could be said  a lot of good news is already priced in. The fact that the shares are down, as I type, would support this argument. 

So, while I’m certainly bullish on Frontier’s outlook, I don’t expect capital gains will be quite so rapid in the next five years as they’ve been since 2016.

If I were to buy now, I’d ensure the rest of my cash was nicely spread across a range to top UK growth stocks before doing so.

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And the performance of this company really is stunning.

In 2019, it returned £150million to shareholders through buybacks and dividends.

We believe its financial position is about as solid as anything we’ve seen.

  • Since 2016, annual revenues increased 31%
  • In March 2020, one of its senior directors LOADED UP on 25,000 shares – a position worth £90,259
  • Operating cash flow is up 47%. (Even its operating margins are rising every year!)

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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has recommended Frontier Developments. 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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