One growth stock I’d buy today with my first £2,000 and one I’d avoid

When you’re in the early stages of building a shares portfolio, it’s often hard to know which stocks to choose. You won’t necessarily have the cash to build a full portfolio immediately.

In my opinion, it’s important to get off to a good start. For me, that means avoiding big losses and hopefully booking some steady profits. The two stocks I’m looking at today both have the potential to deliver handsome profits, but carry very different levels of risk.

Sales up 43% in one year

Shares in online music instrument retailer Gear4music Holdings (LSE: G4M) have risen by 377% over the last two years.

However, progress has stalled over the last year, and the shares slipped lower this morning after the company reported ‘only’ a 43% rise in sales for the year to 28 February. Is this a potential buying opportunity, or a sign that the good news is already in the price?

One potential answer is that the business is starting to mature. Growth has slowed over the last year. UK-specific sales rose by ‘just’ 27% last year, compared to 34% the previous year. And although international sales rose by 69%, this is less than half the 2016/17 figure of 124%.

What about profits?

To some extent, slowing sales are inevitable. Sales are growing from a bigger base, so larger percentages are harder to achieve. But there is a second concern, which is that the group isn’t achieving the kind of profitability investors might be hoping for.

Profits are expected to be broadly flat this year, despite the sales growth of 43%. This means profit margins have fallen. The company says that the main reason for this is investment — Gear4music invested heavily in warehousing and its online platform in 2017.

In today’s statement, chief executive Andrew Wass said that both revenue and profitability should improve in 2018, as last year’s investments pay off. I believe him. But with the shares already trading on 50 times 2018/19 forecast profits, the potential rewards seem outweighed by the risk that the shares could have further to fall. This is too expensive for me at current levels.

Simple and profitable

Homewares firm Portmeirion Group (LSE: PMP) sells ceramics, cookware and table accessories under brands including Royal Worcester, Spode and Wax Lyrical. Not all of these brands are huge in the UK, but they are very popular in North America, which accounts for nearly a quarter of sales.

Indeed, this is a surprisingly profitable business. Sales have risen by an average of 7.5% per year since 2011, while profits have risen by an average of 7% per year.

Return on capital employed — a measure of profitability favoured by long-term investors — is high, at over 15%. This is reflected in strong cash generation and five-year average dividend growth of 10%.

I expect the firm’s growth to continue. And its strong presence in the US market means that I wouldn’t rule out a takeover bid at some point.

You might expect these shares to be expensive. I don’t think they are. Portmeirion trades on a 2018 forecast P/E of 14 with a prospective yield of 3.5%. Given the financial strength of the group’s operations, I think that could prove to be a very good buy.

This could be today's top small-cap buy

The Motley Fool's analysts share my enthusiasm for high-quality small-caps like Portmeirion. To provide ideas for your portfolio, they've published 1 Top Small-Cap Stock From The Motley Fool.

I can't reveal whether the company concerned is Portmeirion. But I can tell you that it's a British company with a good track record of growth. The good news is that this report is free and without obligation. To download your copy and receive full details of this potential buy, click here now.

Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Portmeirion Group. 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.