It’s natural for new investors looking to dip their toes into the market for the first time to go with large-cap stocks that are mostly household names, offer greater perceived stability than smaller companies and are generally mature businesses with big dividend payouts. But the index also offers a surprising number of stocks with stellar growth potential, two of which in particular have caught my eye.
Its biggest test yet
The first is industrial holding company Melrose (LSE: MRO). The company has been in the news of late because of its successful acquisition of automotive and aerospace giant GKN in a cash and stock deal worth some £8.1bn.
The deal, which is by far Melrose’s largest, isn’t without risks, but given the company’s long history of successfully buying, improving and selling on industrial firms for substantial returns, I’m willing to give management the benefit of the doubt. On top of this, GKN is a great target for a cost-cutter such as Melrose.
GKN has leading positions in several key markets but has for years struggled to achieve simple internal targets such as operating margins in excess of 10%. This is where Melrose shines, which is clear in its latest annual results that saw it achieve a 52% rise in operating profits at its recently acquired Nortek business, with operating margins rising significantly to 15.2%.
Given the sensitive nature of GKN’s relationships with aerospace customers, management will need to tread carefully in its usual cost-cutting exercises. However, Melrose is far from an 1980s-style asset stripper and invests substantial amounts in parts of its acquired businesses that have the potential for long-term returns.
This bodes well for the company’s ability to deliver long-term returns from the GKN aerospace business while selling off the automotive and metallurgy businesses that it sees less of a future for. With substantial scope to increase returns at that leading aerospace business, I reckon Melrose’s long, long history of delivering market-walloping returns for shareholders can continue for a long time coming.
Even more financial progress on tap?
Another great business that I think could deliver outsized returns in the coming years is luxury fashion house Burberry (LSE: BRBY). The company has been very successful in recent years in turning around its image and cementing its brand as truly upmarket, which has driven strong sales growth in luxury-loving China and helped boost margins.
With a new management team in place that appears more responsive to investors’ desire for improved financial performance, I reckon this strong competitive position could be turned into even more impressive sales and margin improvements in the years ahead. This would continue recent trends as operating margins have risen considerably in recent years and were up from 12.5% to 14.6% year-on-year in the half to September.
And as the Chinese anti-corruption drive appears to be winding down, there’s good reason to expect previously-wary wealthy Chinese to return to Burberry in droves. This is already starting to play out as in the quarter to December the group recorded a 2% uptick in same-store sales, driven by mid-single-digit growth in the Asia Pacific region.
With a cash-heavy balance sheet, a strong new CEO and creative chief refocusing on the brand’s strengths, and great competitive position, I reckon Burberry could be a fantastic long-term holding for new and experienced investors alike.
