With valuations looking stretched across the LSE, keenly valued stocks of any type are becoming harder and harder to come by. This is especially true of growth stocks, but I think investors looking for both capital appreciation prospects and a bargain would do well to consider kitchen supplier Howden Joinery (LSE: HWDN).
Howden’s stock currently trades at 14 times forward earnings, which is slightly below its average over the past five years. This discount is mainly due to investors turning negative on the medium term outlook for homebuilders and those who supply them. But if you reckon the economy is on a strong footing and continued high demand for new housing and constrained supply will lead to continued new home starts, Howden could be a great way to profit.
The company is growing nicely through both increased demand from home builders and tradesmen at its current trading locations, as well as expanding the number of depots it trades from. In the half year to June 10 the company added 11 new depots to take its total to 653 locations. These new outlets together with a 2.4% year-on-year (y/y) uplift in sales from existing outlets led to UK revenue rising 4% y/y to £539.5m.
Over the medium term the company sees the potential for some 800 locations across the UK, so there’s still plenty of top-line growth prospects. On top of sales growth, I also like that Howden is highly profitable and generates plenty of cash. Operating profits in H1 fell slightly due to the new outlets and a brand new distribution facility, but gross margins remained enviably high at 64%. At period end the company also held £215m in net cash, some of which it is returning to investors through a 2.8% yielding dividend and an £80m share buyback programme.
With plenty of cash saved up for a rainy day, high growth potential and a stable market outlook, I reckon Howden Joinery’s current valuation could represent a great entry point for investors.
Is smaller better?
A smaller and riskier growth stock trading at a low valuation is SME financier 1pm (LSE: OPM). The £48m market cap firm operates through a range of brand names and either provides or arranges financing for small and medium-sized businesses with lease financing, vehicle financing and business loans.
At its current share price, the company trades at just 8.4 times forward earnings despite the firm continuing to post solid growth in both sales and profits. The company’s full-year trading update for the year to March expected sales to be 34% ahead of the year prior at £16.7m and pre-tax profits to rise 28% y/y to £4.3m.
One reason the company’s shares are trading so cheaply is that the non-bank asset financing market is a fairly risky one. Companies such as 1pm that fund the expansion of small businesses have also fallen out of favour over fears about the potential impact of any Brexit-related slowdown on its core customer base.
So far 1pm is showing no ill effects from the Referendum with write-offs during the year of less than 1% of the portfolio, but this is something for potential investors to keep in mind. Investing in any company this small is risky, but with solid growth prospects, respectable profitability and an attractive valuation I’ll keep an eye on it.
If you prefer your investments to be much less risky, I recommend reading the special report on the Motley Fool’s Top Small Cap of 2017. This company has increased earnings by double-digits four years in a row yet its shares still trade at less than eight times earnings.
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Ian Pierce has no position in any of the shares mentioned. The Motley Fool UK has recommended Howden Joinery Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.