Why I’m picking UK growth stocks like this one

Reinstatement of shareholder dividends and a generous earnings forecast makes me keen on this UK growth stock I’ve been watching for a while.

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Many investment strategies can be successful, such as picking UK growth stocks. Equally, investors can struggle to make consistent money from any strategy. But one way for me to increase the chances of success is to find an approach I’m comfortable with and stick with it.

Focusing on UK growth stocks

Having said that, some investors do well by using multiple methods. But my strategy involves aiming to invest in growth companies. So I’m looking for businesses with the potential to increase their earnings and expand their operations year after year. And one stock I’ve been following for some time is education technology and resources company RM (LSE: RM).

But the firm is no FTSE 100 giant. With its market capitalisation around £174m, we can find RM in the FTSE Small Cap index. But I tend to find most of my growth share ideas among smaller enterprises. One general theory is that smaller businesses tend to have more room to grow.

And RM was doing well in the years leading up to the coronavirus crisis. It had been raising the shareholder dividend by increments and the payment was up around 112% over about six years. Although the pandemic caused the directors to stop dividend payments last year.

As well as dividend gains, shareholders enjoyed capital appreciation from a rising share price. And growth in earnings partly drove that outcome. But earnings and the share price have been volatile over the past 12 months.

RM has positive potential as well as plenty of risks in its business. We’ve seen how exterior events can affect trading. Although new pandemics don’t arrive every day, the company does have its operations concentrated in one sector that’s mostly publicly funded. So future changes in government policy could damage the quality of the firm’s trading opportunities, for example.

Business recovery expected

The closure of schools has been a blow for RM. And chairman John Poulter said in today’s full-year results report: “Trading in 2020 was inevitably dominated by the consequences of Covid-19.” In the 12 months to 30 November 2020, revenue dropped by 16% year-on-year. And adjusted earnings per share plunged by 51%.

But despite the ongoing challenges of Covid-19, the outlook is positive and the directors declared a dividend of 3p per share. I think the move to reinstate dividends speaks volumes about their confidence in the firm’s future.

The decision was probably helped by a strong performance regarding net debt, which came in at £1.3m, down from £15m the year before. RM achieved that outcome with a “focus on cash and costs.” But the pension deficit has risen to £18.7m, up from £6m a year ago.

City analysts expect earnings to snap back by just over 30% in the current trading year to November. Meanwhile, with the share price near 211p, the forward-looking earnings multiple is around 13. And the anticipated dividend yield is about 2.3%. Forecast earnings should cover the shareholder payment around 3.5 times. I think the valuation is undemanding compared to the company’s ongoing potential to grow.

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.

Kevin Godbold has no position in any share 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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