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One growth stock I’d add and one I’d avoid in 2017

Shares in the UK’s leading engineering support services provider Babcock International (LSE: BAB) have been on a downward trend ever since they soared to record highs of 1,417p almost three years ago. Investors could be forgiven for thinking that perhaps lower revenues or shrinking profits were to blame. Au contraire. The group has reported higher revenues and pre-tax profits in each of the three years since, and City forecasters are predicting a continuation of this trend.

Too cheap to miss

Sometimes the market can get over-enthusiastic about a company with good prospects, particularly one with a great track record of growth, such as Babcock. Investors can pile in and drive the share price higher until such time that they become overvalued, even after factoring-in a healthy outlook. Eventually the share price rally is over-extended, and a market correction follows. But after losing a third of their value, have Babcock’s shares become too cheap to miss?

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In its most recent half-year report the FTSE 100 group boasted a 12% rise in pre-tax profits to £163.5m, helped by a 7% uplift in revenues to £2,173m from £2,039m a year earlier. Management celebrated with a 7% hike to the dividend, declaring an interim payout 6.50p per share.

Strong order book

The group’s order book also remains strong at £20bn, having been replenished by £2bn of contracted work during the first half of 2016/17. This should provide Babcock with strong visibility of future revenues in the short and medium term with 93% of revenue in place for the full year and 63% for FY 2018.

Analysts are forecasting high single-digit growth in earnings for the next three years, bringing the P/E ratio down to just 10 for the year to the end of March 2019. This compares favourably to the group’s five-year range of between 13 and 17. Furthermore, the steadily improving dividend yields 3% for the current year, rising to 3.4% by FY 2019. I think bargain hunters could do worse than add Babcock to their portfolios.

Appealing growth play

In contrast to Babcock, engineering distribution firm Electrocomponents (LSE: ECM) has seen its shares rocket over the past year, rising an astonishing 130% in the space of just 12 months. The Oxford-based group is the world’s leading high-service distributor for engineers, trading through its RS Components and Allied Electronics brands.

In its last trading update the company revealed a 45% leap in first half underlying pre-tax profits to £55.1m, with revenues up 12.7% to £706.3m, helped by foreign exchange tailwinds and extra trading days. Further earnings expansion looks set to continue, with analysts anticipating strong double-digit rates of growth over the next few years.

But at current levels the shares are trading on a very demanding 25 times forward earnings for the current financial year to March, with the dividend yield sinking to just 2.5%. Electrocomponents remains a very appealing growth play, but I think it would be prudent to wait for a better entry point.

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Bilaal Mohamed 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.