While there are a number of sound investment strategies that have the potential to deliver strong returns and to limit risk, investing in high quality companies seems to be the easiest and most obvious way to maximise your portfolio returns. Certainly, defining what makes a company high quality is very subjective. Some investors may choose to focus on cash flow, profitability or balance sheet strength, while others may prefer to look at the competitive edge that a company’s products or services have over its rivals.
Two notable examples of high quality companies are translation specialist RWS (LSE: RWS), and institutional stockbroker Numis (LSE: NUM). They are both highly profitable businesses, offer excellent value for money and pay relatively high (and sustainable) dividends.
In fact, RWS has been profitable in each of the last five years and, looking ahead, it is forecast to post a whopping 85% rise in its bottom line during the next two years. That’s a superb rate of growth and, despite this, RWS’s shares trade on a price to earnings (P/E) ratio of just 19.9. As such, when the company’s growth prospects and valuation are combined, it equates to a price to earnings growth (PEG) ratio of just 0.5, which indicates that superb growth is available at a very reasonable price.
Furthermore, RWS is expected to significantly increase dividends as a result of its improved profitability, with the company set to yield 3.3% in the current year. And, looking ahead, it would be of little surprise for there to be further dividend increases in future, since RWS’s dividends are presently covered 1.5 times by profit, which indicates that they are very sustainable.
It’s a similar story with Numis. It paid out just 44% of profit as a dividend last year, but that still equates to a very appealing yield of 4.2%. In fact, despite being a relatively cyclical play, Numis remains a hugely enticing income stock and, during the last five years, it has paid out around 34% of its share price from five years ago as a dividend. And, despite having posted a capital gain of 96% in that time, Numis still trades on a P/E ratio of just 10.5, which indicates vast upward rerating potential.
Meanwhile, mobile payments specialist Monitise (LSE: MONI) offers none of the above. Unlike RWS and Numis, it has not been profitable in any of the last five years, is forecast to remain loss-making in each of the next two years, pays no dividend and does not appear to have a clear strategy to become a very profitable and stable business. Furthermore, when it reviewed its strategic options earlier this year, no bids were made for the business.
Certainly, Monitise has a great product, but it is very difficult to label it a high quality business. As such, RWS and Numis appear to be far better places to invest at the present time, with their low valuations and more stable financial performance offering a more favourable risk/return ratio for long term investors.
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Peter Stephens owns shares of Numis and RWS. The Motley Fool UK owns shares of Monitise. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.