One future growth star I’d buy over IQE plc

This small-cap has a much better growth outlook than IQE plc (LON: IQE).

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

IQE (LSE: IQE) has been one of the market’s star performers over the past year. Since mid-January 2017, the shares have gained more than 230%, outpacing all of the UK’s major indexes. 

Unfortunately, over the past three months, shares in the company have struggled as investors have become concerned about the group’s lofty valuation. At the time of writing the shares are trading at a forward P/E of 32.8.

Betting on growth 

For a high-growth company like IQE, this multiple is easy to justify. The City is currently expecting it to report earnings per share growth of 28.5% for 2017 implying a PEG ratio of 1.2. A PEG ratio of one or less signifies that the shares offer growth at a reasonable price based on growth and valuation estimates. For 2018, analysts are projecting year-on-year earnings growth of 31.6%. If the firm hits this target, the shares are trading at a 2018 P/E of 29.1 and PEG ratio of 0.7. 

So if IQE hit its growth targets for the next two years, then the shares look appropriately priced. However, a lot could go wrong over the next two or three years and if IQE fails to live up to expectations, then I believe investors could end up nursing heavy losses as the company’s valuation falls back to earth. 

With this being the case, I believe that small-cap Fairfx (LSE: FFX) might be a better buy for growth hunters. 

Inflection point 

Over the past five years, Fairfx has been struggling to build its business to scale. Even though revenue has grown at a rate of approximately 36% per annum since 2011, the firm has struggled to break even. 

City analysts expect this to change in the next two years and are expecting the financial services company to report a net profit of £8.1m for 2018 and earnings per share of 5.4p on revenues of £2.5bn. 

The firm is already well on the way to this target. Today it reported that revenues for 2017 are on track to exceed £1.1bn, up 39% year-on-year and both revenues and profits are expected to be “ahead of market expectations for FY17.

2018 is set to be an even better year for the firm. At the end of December, it was given full membership status with Mastercard, allowing it to “issue Mastercard branded cards, initially across Europe but with other regions to follow.” This will allow the company to create third-party card programmes in-house producing cost savings as well as streamlining its services. 

Cheap growth 

With Mastercard on-side, management will also be able to accelerate the growth of CardOneBanking, which was acquired last year. CardOne offers a simple banking service for customers with no credit checks and no branches. So far, over 80,000 customers have signed up for the service. 

As Fairfx continues to build on its existing business of international currency payments and complements this growth with other financial services, the group should be able to keep expanding, and margins should improve, leading to further profit growth. 

Unlike IQE, you don’t have to pay a premium for this growth. The shares are currently trading at a forward P/E of 14.2, which I believe undervalues Fairfx and its growth potential. 

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Rupert Hargreaves owns no share 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.

More on Investing Articles

Passive income text with pin graph chart on business table
Investing Articles

Yields of up to 7%! I’d consider boosting my income with these FTSE dividend stocks

The London market has some decent-looking dividend stocks right now, and I’m tempted by these two for growing income streams.

Read more »

Young mixed-race couple sat on the beach looking out over the sea
Investing Articles

I’d put £20K in an ISA now to target a £1,900 monthly second income in future!

Christopher Ruane shares why he thinks a long-term approach to investing and careful selection of shares could help him build…

Read more »

Mature couple at the beach
Investing Articles

6 stocks that Fools have been buying!

Our Foolish freelancers are putting their money where their mouths are and buying these stocks in recent weeks.

Read more »

Black woman using loudspeaker to be heard
Investing Articles

I was right about the Barclays share price! Here’s what I think happens next

Jon Smith explains why he still feels the Barclays share price is undervalued and flags up why updates on its…

Read more »

Investing Articles

Where I’d start investing £8,000 in April 2024

Writer Ben McPoland highlights two areas of the stock market that he would target if he were to start investing…

Read more »

View of Tower Bridge in Autumn
Investing Articles

Ahead of the ISA deadline, here are 3 FTSE 100 stocks I’d consider

Jon Smith notes down some FTSE 100 stocks in sectors ranging from property to retail that he thinks could offer…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

Why I think Rolls-Royce shares will pay a dividend in 2024

Stephen Wright thinks Rolls-Royce shares are about to pay a dividend again. But he isn’t convinced this is something investors…

Read more »

Investing Articles

1 of the best UK shares to consider buying in April

Higher gold prices and a falling share price have put this FTSE 250 stock on Stephen Wright's list of UK…

Read more »