Investing in highly-profitable businesses which generate a lot of cash gives you the opportunity to combine growth and income. This can turn your portfolio into a powerful wealth-building machine.
Here, I consider the appeal of two such income growth stocks. Both have attractive fundamentals, but which one is right for you?
This could be perfect
The world’s biggest mining companies appear to be operating in a sweet spot at the moment. Market conditions have recovered sufficiently from the 2015 slump to make the business very profitable, and the sector isn’t yet in danger of overheating.
Operational costs have fallen sharply and capital expenditure on new projects is being carefully controlled. Management are focused firmly on maximising shareholder returns.
For investors in BHP Billiton (LSE: BLT), this is a potent mix. The group generated free cash flow of $12.6bn last year. This funded $4.4bn of dividend payments and allowed management to reduce net debt from $26bn to $16bn.
History suggests that, at some point, the mining market will enter boom and bust territory again. Executives at companies such as BHP may start to spend too heavily on new projects.
However, there’s no sign of this yet. As things stand today, I believe BHP has the potential to deliver several more years of strong growth.
On this basis, I think the firm’s shares look quite cheap. BHP stock currently trades on just eight times trailing free cash flow and offers a forecast dividend yield of 4.8%. In my view, the stock could be a compelling buy.
Too late to join the party?
While the mining recovery is relatively young, the UK property market has been booming for several years. Many property stocks now look expensive to me, but there may still be some pockets of value.
One potential example is landscape products group Marshalls (LSE: MSLH). The firm’s business is broader than you might think. In addition to products such as paving, which are sold to domestic and commercial customers, Marshalls also produces street furniture, water management products, and various other building materials.
In its recent interim results, the group said that the current pipeline of planning applications in the UK suggests that the requirement for hard landscaping products will increase over the next year. City analysts appear to share this view. They expect earnings per share to rise by a further 12% in 2018.
In my view, one of Marshalls’ main attractions is the high level of returns being generated by the business. The group’s return on capital employed (ROCE) rose to 23.7% during the first half of the current year, up from 19.9% for the same period last year. As a general rule, a figure of 15% is high, so these are impressive figures.
What’s less clear is how much upside is left for investors. The stock currently trades on a 2017 forecast P/E of 22 with a dividend yield of just 2.5%. In my view, this already reflects the stock’s high ROCE and does carry some downside risk.
If you believe that the property market can continue to grow, then Marshalls could still be a good buy at current levels. Personally, I’m not tempted at this stage.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.