With the prospects for the global economy being generally upbeat, many companies are forecast to post improving levels of profitability over the next couple of years. As such, their valuations have often risen to levels which reduces their investment potential. Narrow margins of safety could mean that the risk/reward ratio is no longer in an investor’s favour for many stocks.
However, within the industrial sector there continue to be some strong growth opportunities which still trade on low valuations. Here are two prime examples which could be worth investing in today.
Reporting on Tuesday was Melrose Industries (LSE: MRO). The company’s 2017 financial year was relatively successful, with the performance of Nortek being strong. It was able to deliver revenue growth of 2%, with increased momentum in the second half of the year. Operating profit was up 52% on the prior year, and is up 67% on the last full year prior to its acquisition.
Of course, significant restructuring costs were incurred in the first full year of Nortek ownership by Melrose. However, the company’s long term future appears to be positive. So too does that of another of Melrose’s businesses, Brush. Consultations with employees have commenced, with the view to putting in place a restructuring plan.
Looking ahead, Melrose is forecast to post a rise in its bottom line of 4% this year, followed by further growth of 14% next year. This puts it on a price-to-earnings growth (PEG) ratio of just 1.4, which suggests that it could offer a high rate of return. With the company having a proven business model, its performance could improve in future years as it continues to execute its growth strategy.
Also operating in the industrials sector is automotive specialist GKN (LSE: GKN). The company has been the target of an unsolicited approach by Melrose, which it has sought to fight off. GKN believes it is well-placed to deliver a successful turnaround, and that it is putting in place the right strategy to do so.
Looking ahead, the market consensus suggests that this is the case. It is due to report a rise in earnings of 13% this year, followed by further growth of 11% next year. This puts the company’s shares on a PEG ratio of 1.1, which indicates that they are undervalued at the present time. Certainly, there is a risk that the company will be unable to effect a successful turnaround, but this seems to have been factored into its valuation.
While there is the potential for a combination between Melrose and GKN, it seems unlikely to happen at the present time. Of course, this may change in future and it could mean that investors in both companies end up with one slice of the merged group. However, with the companies being fairly well-diversified, they are likely to offer favourable risk/reward ratios in the long run.
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Peter Stephens owns shares in GKN. The Motley Fool UK owns shares of GKN and Melrose. 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.