The Motley Fool

This stock has 20% upside by 2019

Brexit looks set to cause problems for UK-focused stocks. In particular, retailers and banks could see their financial performance come under pressure if inflation rises and puts a squeeze on disposable incomes. Therefore, investing in companies which not only have geographic diversity, but also defensive characteristics, could be a sound move. This company in particular could be worth buying, since it has 20% upside thanks to a low valuation and sound business model.

Bucking the trend

Whitbread‘s (LSE: WTB) performance in the credit crunch took many investors by surprise. Its Premier Inn division enjoyed a purple patch as consumers traded down to cheaper accommodation options. Given the potential for a reduction in disposable incomes in real terms due to higher inflation, the same process could happen in the next couple of years.

Whitbread’s other main division Costa remains exceptionally popular and was its best-performing segment in the company’s most recent update. Its sales and profitability should remain robust even in the face of a worsening consumer outlook because many of its customers will regard Costa coffee as an essential item. Therefore, Whitbread should be able to pass on higher import costs, higher labour costs and any other additional costs on to its customers without seeing a commensurate fall in sales.

Growth potential

Whitbread currently trades on a price-to-earnings (P/E) ratio of around 16.5. This may sound relatively high, but it is lower than the five-year average rating of 19.4 which has been applied by the market to the company’s shares. If it was to trade at its historic average, Whitbread’s share price would move around 18% higher. This could take place over the next couple of years, as its performance should remain relatively robust.

Added to this gain from an upward re-rating could be earnings growth. The company is forecast to record a rise in its bottom line of 6% in the next financial year, plus 9% the year after. This means there could be over 20% potential upside on offer over the next two years. Given the challenging outlook for the wider index, this is likely to be a strong result.

Defensive play

Of course, for investors seeking an even more defensive stock, food services company Compass Group (LSE: CPG) could be worth a closer look. It trades on a P/E ratio of 20.1 and while this is higher than its five-year average of 19.7, the company is forecast to record a rise in its earnings of 17% this year, followed by further growth of 7% next year. As such, it seems to be trading at fair value given its upbeat outlook.

In addition, Compass Group offers a high degree of geographic diversity, which lowers its risk profile. It also means it could benefit from a positive currency effect over the medium term. Furthermore, while the FTSE 100 may remain volatile in the coming months, Compass Group’s beta of 0.6 could equate to a less volatile shareholder experience. Of course, sector peer Whitbread appears to have a superior risk/reward ratio, but Compass may be a top performer too.

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Peter Stephens owns shares of Whitbread. 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.