I like investing in high-quality companies that have strong revenue growth, high levels of profitability, and solid balance sheets. That’s because history shows these kinds of businesses tend to be excellent long-term investments. Recently, I screened the FTSE 250 for high-quality stocks within the index. Here’s a look at two names that came up.
A top technology stock
First, we have Kainos (LSE: KNOS). It’s a technology company that helps public and private organisations with digital transformation (cloud computing, data analytics, artificial intelligence, etc).
This company ticks a lot of boxes when it comes to quality. For starters, it’s generating excellent growth due to high demand for digital transformation solutions. Over the last five financial years, its revenue has climbed from £97m to £375m. Looking ahead, analysts expect the growth to continue (although not at the same pace).
It’s also very profitable. Over that same period, return on capital employed (ROCE) has averaged 43%, which is outstanding. Companies that can generate that kind of profitability often grow much bigger because they have a lot of money to reinvest for growth.
Meanwhile, the balance sheet’s strong. At 30 September, Kainos had £113m in cash and no debt.
But It’s not perfect. One downside is that there’s some customer concentration risk. For example, the NHS is a major customer. And recently, it has experienced post-pandemic budget constraints, leading to lower revenues for the FTSE 250 company.
Overall though, this is definitely a high-quality business. And trading on a forward-looking P/E ratio of 22 with a dividend yield of around 2.2%, I think the stock looks attractive.
If I didn’t already own some Kainos shares, I’d be a buyer today.
A well-known name
The other stock I want to highlight is Greggs (LSE: GRG), one of the leading food-on-the-go retailers with nearly 2,500 shops across the UK.
This is another company with a strong track record when it comes to growth. Between 2017 and 2022, revenue climbed from £960m to £1,513m. For 2023 and 2024, analysts are expecting top-line figures of £1,800m and £1,994m respectively.
And like Kainos, it’s very profitable. If we exclude the 2020 pandemic year, ROCE averaged 22.1% between 2017 and 2022, which is excellent.
It’s worth pointing out that one of this company’s major strengths is its brand. Across the UK, Greggs is a well-known name. And the name is synonymous with good value takeaway food (and steak bakes, of course). This is a competitive advantage.
To my mind, the biggest risk here is market saturation. With a high penetration of stores across the UK already, there are questions as to whether Greggs can keep growing at a healthy rate. This is an issue to think about.
All things considered though, I think this stock has a lot of appeal. It’s currently trading on a forward-looking P/E ratio of 20, which I think is reasonable, and offering a dividend yield of about 2.5%.
This could be one for my portfolio in the future.
