Buying stocks which have delivered a disappointing share price performance can be a highly profitable move for long-term investors. In many cases, there is a wide margin of safety on offer, while the upside potential may be higher than the downside risks.
With engineering support company Babcock (LSE: BAB) having fallen by 27% in the last year, it is clear that investor sentiment is weak. However, with a low valuation and positive earnings growth forecasts, could it be a FTSE 100 stock that helps to make you a million?
The company released news of a contract win on Monday. It has been awarded a 10-year contract to supply Sellafield with specialist handling and containment systems to process nuclear material. The contract will be delivered by Babcock’s subsidiary, Cavendish Nuclear, and could be worth up to £95m over the first three years of its life. With the subsidiary having experience in working with Sellafield and the resources to deliver the project, it could have a positive impact on the company’s financial and share price performance.
As mentioned, Babcock has fallen significantly over the last year. Its shares now trade on a price-to-earnings (P/E) ratio of 8.6, which given the firm’s size and scale appears to be exceptionally low. It suggests that investors have priced-in a very challenging and disappointing future for the business.
Looking ahead though, the company is expected to record a rise in its bottom line of 3% in the current year, followed by further growth of 4% next year. Certainly, these figures are below those of the wider index, but they suggest that the firm is performing relatively well at an uncertain time for the wider industry. As such, now could be a good time to buy the stock for the long term.
Also offering an impressive growth rate is wealth manager Hargreaves Lansdown (LSE: HL). It is expected to post a rise in its bottom line of 11% in the current year, which comes after a period of relatively solid performance. For example, in the last five years the company has been able to deliver a rising bottom line 80% of the time, with its annualised earnings growth rate being over 13%.
The problem for investors though, is that the company’s valuation appears to adequately factor-in its growth outlook. Hargreaves Lansdown may have a dominant position within its industry, but it trades on a P/E ratio of 34.2. This suggests that it is overpriced and that if its growth rate disappoints versus forecasts, it could lead to severe falls in its share price.
Certainly, the company has a sound strategy as well as the potential for increasing profitability as the current Bull Run continues. But with the likes of FTSE 100-peer Babcock trading on lower valuations, there could be more attractive investment opportunities in other parts of the index.
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Peter Stephens owns shares in Babcock. The Motley Fool UK has recommended Hargreaves Lansdown. 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.