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Why IQE’s share price could be set for a rebound

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The last year has been disappointing for investors in wafer product manufacturer IQE (LSE: IQE). Its share price has fallen by 37% during the period, with investor sentiment coming under pressure after slightly disappointing financial results.

But this could present a buying opportunity. The company’s long-term investment prospects seem to be sound, with a relatively low valuation suggesting that it may offer a wide margin of safety. As such, it could offer upside potential at a time when a number of shares appear to be overvalued. An example of such a share is an AIM-listed company that released a trading update on Thursday.

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High valuation

The company in question is manufacturer of optical components and systems, Gooch & Housego (LSE: GHH). Its full-year trading update showed that performance in the year to 30 September 2018 has been in line with expectations. It has benefitted from positive market conditions in the industrial sector. Demand for critical components used in microelectronic manufacturing has been high, while sales of high reliability fibre couplers for undersea cables have also helped to boost its overall performance.

The business has a record order book which stands at £96.1m. This is an increase of 33% compared to the same period of the previous year. It has a strong financial position which should allow it to continue to invest for the long term as it seeks to execute its strategy.

However, with the Gooch & Housego share price having risen by 26% in the last year, it now appears to lack a margin of safety. Despite being forecast to post a rise in earnings of 15% in the current year, a price-to-earnings growth (PEG) ratio of 2 suggests that it may be a stock to avoid at the present time.

Improving outlook

As mentioned, the financial performance of IQE has been somewhat disappointing in recent months. The company has reported lower profitability as it seeks to invest for long-term growth. As a result, its bottom line is expected to fall by around 1% this year. This puts it on a forward price-to-earnings (P/E) ratio of around 28 for the current financial year.

However, next year the performance of the business is due to improve significantly. It is expected to post a rise in earnings of 43%, which puts it on a price-to-earnings growth (PEG) ratio of 0.7. This suggests that it offers a wide margin of safety that could mean there is recovery potential over the coming years.

IQE’s recent update may have shown a fall in profitability, but the company was hit by negative currency adjustments. It continues to invest in its production facilities, while demand within its operating segments remains high. As such, from a long-term investment perspective, it seems to have significant appeal. Certainly, volatility could continue to be high, and there may be further disappointment ahead in the near term. But in the long run, a turnaround could be on the cards.

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Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has recommended Gooch & Housego. 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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