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Why I’d buy this hot growth stock over IQE plc

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I reckon the underlying growth story at NEX Group (LSE: NXG) is a good one, and recent weakness in the share price is giving us a good opportunity to research the stock as a potential ‘buy’.

The firm provides trading platforms, expertise and other services for global banks, asset managers, companies and others, and today’s interim results suggest ongoing growth potential. Revenue from continuing operations lifted 7% on a constant currency basis compared to a year ago and operating profit excluding one-off items held steady with a minor 1% decrease. However, underlying earnings per share came in 13% lower and the directors declared a much-reduced interim dividend of 3.5p per share, which compares to last year’s payment of 11.5p.

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A progressive dividend policy

Looking forward from this lower dividend level, NEX has plans to deliver a progressive dividend policy, which it says will be set between 40% and 50% of post-tax trading profit. Growth opportunities and cost savings look set to keep earnings rising from here with the directors announcing that they’ve identified the potential for £40m in annual cost savings over the next three years. City analysts following the firm expect earnings to come in 11% higher for the full year to March 2018 and 34% up to March 2019.

Chief executive Michael Spencer reckons the firm has seen a transitional and transformational year.” He expects NEX to achieve compound annual revenue growth of 7% to 10% and operating margins of more than 40% for its NEX Optimisation and NEX Markets divisions by the 2019/20 full trading year.

A question of valuations

Meanwhile, today’s share price of around 586p throws up a forward price-to-earnings (P/E) ratio a little under 17 for the year to March 2019 and the forward dividend yield runs just over 2.8%. Those anticipated forward earnings should cover the payment more than twice.

I reckon the valuation looks reasonable and the firm could make a more comfortable hold than IQE (LSE: IQE), for example.

IQE’s successful placing of new shares raised £95m on 10 November at a price of 140p per share. I reckon that’s quite an achievement for a company that was trading at just 30p per share a year before that and it underlines the potential for growth that investors see in the firm’s business of manufacturing advanced wafer services for the semiconductor industry.

Ramping up capital investment

The directors want the extra money to ramp up capital expenditure aimed at scaling the business for “multiple high growth mass-market opportunities.”  The story has captured the imagination of many, and if we do end up seeing IQE’s products in mass-market smartphones and the like, we could witness profits multiplying many times down the road.

However, with the share price standing around 173p, the forward P/E rating for 2018 runs at 41, which seems high considering that City analysts predict growth in earnings of just 27% that year. It’s true that earnings could explode if mass-market adoption of IQE products happens, leaving the analysts scurrying to catch up. But equally, delays or disappointments could materialise to knock the share price down again. I think you need nerves of steel to hold IQE today, so I’d be more inclined to consider Nex Group as a potential investment.

 

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Kevin Godbold 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.

 
 
 
 

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