Advertising company WPP (LSE: WPP) has performed well recently, with shares in the company up 10% since the start of the year. WPP has achieved impressive growth over the last few years, but can the company continue to deliver attractive returns given near term macroeconomic headwinds?
Short-term benefits
Those concerned by June’s Brexit vote and slowing global growth would probably be assuaged by WPP’s latest set of results. Revenues for the first half of its 2016 financial year expanded 9.3%, and that helped pre-tax profits to rise 15.8%, to £690m.
However, it is worth pointing out that WPP had benefited from a number of short-term events, such as Euro 2016, the Rio Olympics and the upcoming US presidential election, all of which helped to drive an increase in global advertising spending this year.
Looking forward, I expect the headwinds from a slowing global economy to drag on earnings more noticeably as this seasonal effect dissipates. After all, advertising revenues are highly correlated with the pace of economic growth.
Trading on a price-to-earnings (P/E) ratio of 18.0, WPP doesn’t look particularly appealing. But thanks in part to a weak pound, city analysts expect adjusted EPS to climb 16% this year, which means its forward P/E falls to a more reasonable figure of 15.8.
From an income perspective, the stock is more attractive given expectations of robust dividend growth over the next two year. For 2016, city analysts forecast dividends to rise of 20%, with a further increase of 11% pencilled in for 2017. These gives it prospective yields of 3.1% and 3.5% for 2016 and 2017, respectively. And on top of this, management plans on buying back shares worth around 2-3% of its issued share capital each year.
Limited margin growth
Another growth stock looking expensive is food services company Compass Group (LSE: CPG). The company has a great track record in delivering rapid growth, with its shares having delivered a total return of 167% over the past 5 years. But, I’m cautious about how much further shares can climb before a correction kicks in.
Margin expansion came to a halt last year, with underlying operating margins flat at 7.2%, and concerns mounting that rising costs and a focus on expansion mean the potential for margin growth is limited. So although the company has been delivering steady organic revenue growth, earnings growth appears to be slowing because of weakness in margins.
Nevertheless, Compass is exposed to long-term structural tailwinds as the market for outsourcing expands. There’s plenty of scope for expansion because less than half of the global market is currently outsourced and there’s pressure on governments in many countries to make cost savings.
In the short term, the company is set to benefit from the weaker pound. It earns around 90% of its earnings from outside of the UK, so if current exchange rates persist, the group could expect to get a positive earnings translation boost of around 7% on this year’s profits.
The shares are rather expensive though — they currently trade at a forward P/E of 24.3, given forecasts of earnings growth of 11% this year. This also compares unfavourably to its 5-year historical forward P/E of 21.8, which suggests that shares in Compass are overvalued.
