Finding bargains within the FTSE 100 has become more difficult after its 19% rise in the last year. The index has reached a record high in recent months, so high valuations are perhaps to be expected. Despite this, there are a number of cheap stocks with significantly superior growth potential compared to the wider index. Here are two prime examples which could deliver strong total returns over the medium term.
High-growth technology stock
Payment specialist Worldpay (LSE: WPG) has endured a disappointing year. Its shares have fallen by 7%, which means they now appear to be trading in bargain territory. The company’s growth outlook remains sound, with earnings growth of 12% forecast for the current year. This is expected to be followed with growth of 16% in 2018, which suggests a reversal in investor sentiment could be about to take place.
Despite Worldpay trading on a price-to-earnings (P/E) ratio of 23, its growth outlook indicates its shares could be worth buying. It has a price-to-earnings growth (PEG) ratio of just 1.6, which seems to be rather low for a well-established, large-cap technology company. Its growth outlook is likely to be more consistent and dependable than is the case for many of its sector peers, which means that its risk/reward ratio could be favourable.
It could even become a relatively enticing income stock in the long run. Worldpay currently yields 1%, but is forecast to raise dividends by 25% in the next financial year. While it may take time for its yield to beat that of the wider index, rapidly rising dividends indicate management confidence in its future, which bodes well for its investors.
Engineering, medical and technology company Smiths Group (LSE: SMIN) is probably one of the most diversified businesses in the FTSE 100. It offers a mix of resilient earnings as well as long-term growth potential. Its shares trade on a P/E ratio of 16.4 and while this is relatively high, the company’s risk/reward ratio remains attractive thanks to its forecast growth rate. It is expected to record a rise in its bottom line of 6% this year and 8% the year after.
As well as a relatively low risk profile and upbeat earnings growth outlook, Smiths Group remains a solid income play. It currently yields 2.9% from a dividend which is covered 2.1 times by profit. This indicates that there is scope for dividend payments to rise at a faster pace than earnings over the medium term. Given the expectations for a higher rate of inflation in future years, Smiths Group’s dividend profile could become increasingly attractive. And when coupled with that low risk profile, its status as a popular income share could be enhanced.
Certainly, the potential slowdown in global GDP growth is a cause for concern. Smiths Group would be hurt by a global slowdown, with its technology and engineering operations likely to be most affected. However, its current valuation appears to include a margin of safety, which could make now the perfect time to buy it.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has recommended Worldpay. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.