Why I’d Buy 7Digital Group PLC, Topps Tiles Plc, But Would Sell Associated British Foods plc

Shares in Associated British Foods (LSE: ABF) are among the top risers today, being up over 5%, after the company released an update that confirmed its full-year guidance. Encouragingly, ABF reported strong sales growth at its Primark discount clothing chain, with impressive numbers being reported in many of Europe’s struggling economies such as Spain and Ireland. Meanwhile, Twining’s Ovaltine continues to improve its profitability, with Allied Bakeries continuing to provide robust performance.

Despite this, ABF’s bottom line is still expected to fall by 6% in the current year. And, looking ahead to next year, it is forecast to rise by 7%, which is in-line with the wider market’s growth rate. However, ABF continues to trade at a major premium to the wider index, with it having a price to earnings (P/E) ratio of 31.4, which is more than double the FTSE 100’s P/E ratio.

Certainly, ABF is a great business that is well-diversified (both in terms of its products and its regional exposure), has a great management team and is extremely defensive and robust during challenging economic periods. However, with disappointing growth prospects, it is difficult to justify a P/E ratio of even two-thirds of its current level. As such, and while its shares have performed well in the last five years (rising by 210%), its future share price performance could be less impressive.

Meanwhile, two stocks that offer greater risk than ABF (but also the potential for greater reward) are Topps Tiles (LSE: TPT) and 7Digital (LSE: 7DIG). In the case of the former, it looks set to benefit from an improving UK economy, with its bottom line forecast to rise by 30% in the current year, followed by growth of 12% next year. And, with its P/E ratio being 17.1, this equates to a price to earnings growth (PEG) ratio of just 1.3, which indicates that growth is on offer at a very reasonable price.

Certainly, Topps Tiles is not as stable as ABF, with its bottom line having fallen in three of the last five years. But, unlike ABF, it appears to offer good value for money and a clear catalyst for share price growth over the medium to long term.

Of course, 7Digital is undoubtedly a higher-risk stock than both ABF and Topps Tiles, since it has been loss-making in each of the last five years and is expected to do the same in each of the next two years. However, its shares have risen by 11% today after the release of a positive trading update which shows that the company continues to benefit from the industry shift from downloading music to streaming. In fact, this is contributing to a rise in 7Digital’s gross margins, with them being expected to hit 60% this year; up from 49% last year.

Furthermore 7Digital has several new contract wins, such as Jazz FM and Mariposa Holdings, which intend to launch new services over the short to medium term, as well as with NEC in Australia. And, with a healthy sales pipeline and a debt-free balance sheet, it could prove to be a strong long-term performer for less risk-averse investors.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.