Buying shares which have made strong gains may seem like a foolhardy approach to many investors. After all, if a company’s share price has already made gains, it could be argued there is less upside left available for new investors. However, this approach assumes there is a finite amount of capital growth on offer, which is unlikely to be the case. As such, G4S (LSE: GFS) could be worth a closer look even after its shares rose by a third in the last year.
The company’s full year results were released on Wednesday, and show it is making encouraging progress. For example, its continuing businesses delivered revenue growth of 6.3% and earnings growth of 16.6%. This provides evidence that the transformation strategy is performing well. G4S now appears to have stronger financial foundations and has gradually become a more efficient business with more impressive margins.
The company’s new contract sales total £2.5bn, while its pipeline of new orders has a £6.8bn annual value. Encouragingly, performance in developed and developing markets was strong, with the former’s revenue up 6.8% and the latter recording sales growth of 5.4%. And with operating cash flow from continuing businesses 61.5% higher at £638m, G4S seems to be well-positioned for future growth.
Capital gain potential
In fact, the company’s outlook is equally positive. In 2017, G4S is forecast to record a 16% rise in earnings and is due to follow this up with growth of 10% next year. Clearly, this is well ahead of the FTSE 100’s growth rate and means that G4S could justify a higher rating.
It currently trades on a price-to-earnings growth (PEG) ratio of just 1.4, which indicates there is further capital gain potential even after its recent rise. And since its transformation strategy is not yet complete, more impressive earnings growth could lie ahead in 2019 which has yet to be factored into its valuation. As such, a further share price gain of a third seems relatively likely over the medium term.
Of course, it’s not the only support services company with upside potential. Home emergency, repair and heating specialist Homeserve (LSE: HSV) may also have a bright future. It is forecast to record a rise in its bottom line of 20% this year, followed by further growth of 10% next year. This puts it on a PEG ratio of 1.6, which indicates that its share price could move higher after its 31% gain in the last year.
While Homeserve’s valuation is higher than that of G4S, it arguably comes with less risk. Homeserve’s business model appears to be more stable than that of its sector peer. Evidence of this can be seen in its track record of relatively consistent growth, while G4S has a more volatile earnings history. However, given its continued progress and wider margin of safety, G4S appears to be the better buy of what seem to be two highly attractive growth stocks.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has recommended Homeserve. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.