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One monster growth stock I’d buy before IQE plc

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When I wrote about semiconductor wafer manufacturer IQE (LSE: IQE) in January, I suggested that the shares could be worth buying at under 110p.

The shares fell to 100p early in February, but have since bounced back to around 140p. So should you continue to buy this stock?

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What just happened?

Last month’s dip seems to have been the result of two short-selling reports, released by analysts betting on the shares to fall. As things stand, I don’t think they’ve found a smoking gun. There doesn’t appear to be any evidence of serious problems at IQE.

Brokers covering the stock certainly weren’t moved by the reports. Their consensus view of expected earnings for 2017 and 2018 has remained unchanged. Adjusted earnings are expected to have risen by 8% to 3.25p per share in 2017. An increase of 30% to 4.25p per share is expected for the current year, putting the stock on a forecast P/E of 34.

My view on IQE

Sales of the firm’s advanced wafers seem to have risen strongly in 2017, especially Infrared products (+10%) and Photonics (+100%). The company believes that its intellectual property and scale has given it “a sustainable lead” in the Photonics market.

Although the shares might look expensive on a 2018 P/E of 34, forecasts for strong earnings growth give the shares a price/earnings growth (PEG) ratio of 0.9. That’s not expensive. Indeed, a PEG ratio of less than one is often seen as cheap.

However, the company’s past performance hasn’t really convinced me that it has the exceptional growth rate or the high profit margins needed to become a tech superstar. My view remains that these shares are a little too expensive.

One growth stock I would buy

I’ve owned shares in internet marketing group XLMedia (LSE: XLM) before. Having looked at today’s figures from the firm, I wish I’d held onto them.

This company makes money by generating online leads for other firms, mainly in the gambling sector. Sales have risen by an average of 38% per year since 2011, while profit growth has averaged about 25% each year.

These growth rates were largely maintained in 2017. Sales rose by 33% to $137.6m last year, while pre-tax profit rose by 27% to $39.3m. Earnings per share rose by 25% to $0.15, putting the stock on a trailing P/E of 17.

Why I like this stock

XLMedia has faced concerns about its heavy exposure to the gambling sector. So far, it seems to have been plain sailing. But the company is now taking steps to diversify into other potentially profitable areas, such as personal finance and cyber security.

After a long period of fairly slow gains, the shares have risen by 60% over the last year. One attraction is that the group’s profit margins have been consistently high. XLMedia generated an operating margin of 29.6% last year.

The shares have fallen 4% today, perhaps because earnings are only expected to grow by 8% this year. Personally, I’m not too concerned. XLMedia has the cash needed to make further acquisitions and if this isn’t possible, then it might return some of these funds to shareholders.

Trading on 16 times forecast earnings and with a 3.1% yield, I believe this stock remains a buy for growth.

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Roland Head 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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