Should you sell Johnson Matthey plc and buy this smaller peer?

Should you put your faith in a 200-year old FTSE 100 heavyweight, or target rapid growth with a cash-rich FTSE 250 company? In this article I’ll take a closer look at both firms and give you my verdict.

Don’t underestimate this firm

Underlying pre-tax profit rose by 5% to £219.6m at chemical group Johnson Matthey (LSE: JMAT) during the six months to 30 September. But this solid figure was largely the result of currency benefits. Stripping out favourable exchange rates reveals that the firm’s underlying profit fell by 3%.

I don’t think shareholders need to be concerned by the group’s minor profit dip. Johnson Matthey’s 200-year history means it can make a reasonable claim to be a long-term business. The group increased the interim dividend by 5% to 20.5p today, as a sign of confidence in its medium-term prospects.

A number of new initiatives are under way to power future growth. Perhaps most notable is the group’s battery technologies division, which is targeting electric vehicle manufacturers. Sales of battery materials rose by 16% to £72m during the first half. Johnson Matthey expects the unit to break even during the 2017/18 financial year.

Is Johnson Matthey a buy?

The group expects to meet full-year profit expectations. Current forecasts suggest adjusted earnings of 194p per share are likely this year, giving a forecast P/E of 17.2. This should fall to a P/E of 16 in 2017/18.

Johnson Matthey shares have risen by 30% over the last year, while earnings expectations have fallen slightly. This means that the stock’s valuation has risen from a forecast P/E of 13 one year ago, to an equivalent P/E of 17.2 today. This has pushed the dividend yield down to about 2.4%.

Although these shares aren’t the bargain they might have been a year ago, I believe Johnson Matthey’s track record suggests the stock remains a decent long-term buy.

Does this small stock have stellar potential?

Shares of FTSE 250 group Elementis (LSE: ELM) have risen by nearly 20% over the last six months, and by 82% over the last five years. The group’s most recent trading statement highlighted its strong cash generation. Shareholders will be rewarded with increased dividend payouts that are expected to provide a 4.5% yield this year.

Unfortunately, the underlying picture isn’t quite so bright. Although Elementis is generating cash, earnings growth is weaker than at Johnson Matthey. Earnings per share are expected to fall by 6% this year, before rising by a similar amount in 2017.

Elementis trades on a forecast P/E of 18, falling to a P/E of 17 in 2017. This valuation looks up with events at the moment. However, it has a number of opportunities for growth over the next few years. Conditions in the key North American markets of oilfield drilling and chromium may well improve, the group’s personal care division reported a 38% rise in sales during the third quarter and further growth is expected.

I believe the medium-term outlook is positive. I’m also encouraged by the group’s strong profit margins and attractive dividend yield. In my opinion, the current share price could be a reasonable entry point for long-term investors.

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