I reckon there are two types of successful growth stock. One type is expensive but worth it, as profits are skyrocketing. The other type always looks reasonably priced, as its share price simply rises alongside its earnings.
Both companies can deliver impressive gains. But they offer a different mixture of potential risk and reward. In this piece I’m going to look at one company of each type and explain which I’d buy.
Beating market forecasts
Pawnbroking firm H&T Group (LSE: HAT) gained 8% on Friday morning after the company said that pre-tax profit for the full year would be “above current market expectations”.
Chief executive John Nichols said that the company had delivered a “strong trading performance” across its pawnbroking, retail and personal loan businesses. A stable gold price also helped to maintain profits at the group’s gold buying business.
H&T’s personal loan offer is a relatively new venture, and is growing fast. During the first half of the year, the loan book increased by 87% to £11.8m. I’d imagine the troubles experienced by doorstep lender Provident Financial in recent months may have provided a further boost in demand for this service, over and above its existing growth rate.
Although the group’s shares have risen by 38% so far this year, the stock remains reasonably priced. It’s also backed by a very strong balance sheet.
Net debt at the half-year stage was just £11m, which is very modest compared to trailing profits of £9.5m. The group’s net asset value at the end of June was 273p per share, so even at today’s price of 360p, the stock only trades at 1.3 times its book value. That’s very affordable for an asset-backed business of this kind, in my view.
The share price also looks reasonable relative to earnings, with a 2017 forecast P/E of about 14 and a prospective yield of 3.1%. I believe these shares could continue to perform well for some time to come.
Ready to deliver?
Another company that’s likely to continue performing well is Just Eat (LSE: JE). This company represents the other type of growth stock — the shares look pricey, but rapid earnings growth means that the price could be justified.
After all, analysts expected earnings per share to rise by about 40% this year and again in 2018. On that basis, a forecast P/E rating of 46 may not be too high.
However, for new investors I think it’s important to remember that forecasts about future earnings growth are already priced into the stock. Further gains will require a stronger bull market — which I find hard to imagine — or else earnings growth beyond current forecasts.
I’m fairly confident that this is an excellent business, with the potential to achieve a similar level of domination as Rightmove. But it’s worth remembering that Rightmove’s share price hasn’t really risen since the end of 2015. The business is gradually de-rating onto a more mature valuation.
I don’t think Just Eat has reached this point yet. But if the group’s profits ever come slightly below expectations, the shares could fall sharply. There’s also no dividend. In my view, the risks may soon outweigh the potential rewards for new investors.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Just Eat and Rightmove. 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.