Investing in shares which have low price-to-earnings (P/E) ratios can sometimes be a sound strategy. However, a number of stocks are highly rated and this could cause many investors to rule them out. This could be a major error, since such companies can provide high long-term rewards if their profitability rises sharply. Here are two companies which provide prime examples. They could make you rich even though they have relatively high P/E ratios.
A new strategy
Tesco (LSE: TSCO) has a P/E ratio of 26 that may appear to be exceptionally high given the uncertain outlook for UK retailers. After all, Brexit may lead to reduced consumer confidence and lower spending, even on essential items. In addition, the competitive pressures of the supermarket sector are showing little sign of ebbing. Therefore, Tesco’s outlook is undoubtedly challenging.
However, the company’s strategy of focusing on food, efficiencies and expansion into new areas, as evidenced by the Booker acquisition, means that its bottom line is forecast to rapidly rise. For example, in the next financial year it is forecast to increase by 31% and then by 30% the year after. When combined with its P/E ratio, this puts the company on a price-to-earnings growth (PEG) ratio of less than one.
Certainly, Tesco is a relatively risky stock to buy at the present time. Its acquisition of Booker will take time to integrate and it will attempt to do so while implementing a revised strategy in its other operations. It may also make disposals within its international operations in order to focus on the UK. All of these changes may make the stock a more volatile place to invest in 2017. However, they could also turn it into a winning investment.
A stable stock worth paying for
Stability in 2017 seems to be in short supply. Already, the FTSE 100 has yo-yoed this year and it would be unsurprising for this to continue. Against this backdrop, Coca-Cola HBC (LSE: CCH) offers a relatively robust and predictable outlook. For example, it is expected to record a rise in its bottom line of 15% this year, followed by 14% next year. Therefore, while its P/E ratio of almost 23 is rather high, it seems to price the company fairly given its double-digit growth prospects.
While a share price rise of 40% in the last year has made the stock less enticing as a dividend play, it continues to have sound income potential. For example, in the next two years its shareholder payouts are forecast to rise at an annualised rate of over 14%. This puts it on a forward dividend yield of 2.6%. Since dividends are covered more than twice by profit, there is scope for further dividend growth over the long run. This could act as a positive catalyst on Coca-Cola HBC’s share price and lead to even higher total returns in the coming years.
Becoming a millionaire
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Peter Stephens owns shares of Tesco. 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.