The Motley Fool

Why I’d shun the IQE share price and buy this FTSE 250 growth stock instead

AIM-listed IQE  (LSE: IQE) and FTSE 250 firm Morgan Advanced Materials  (LSE: MGAM) both saw hefty declines in their share prices in 2018. However, both have also enjoyed a bit of a recovery so far this year.

In this article, I’ll discuss the valuations and growth prospects of the two companies, explaining why I’d avoid IQE, but be happy to buy into Morgan Advanced Materials.

Bees knees

IQE has generated a lot of excitement on financial discussion boards over the last couple of years. The company claims to be “the leading global supplier of advanced semiconductor wafers.” That’s not “a” leading supplier, mark you, but “the” leading supplier.

The bull case in a nutshell is that IQE’s wafers are the bees knees and that demand from customers who use these materials to produce high performance wireless, photonic and electronic devices, or ‘chips’, is set to skyrocket in the age of the Internet of Things.

Delayed take-off

Unfortunately, a big step-up in sales and profits projected for 2018 didn’t materialise. A warning of weak iPhone sales by Apple in November reverberated down the supply chain. IQE slashed its guidance on 2018 revenue and EBITDA to £160m and £37m, respectively. This guidance was lowered again — to £156m and £27.5m — in a further update last month. Far from 2018 being a watershed year, the revenue number represents zero growth from 2017, while EBITDA is 26% down on 2017’s £37m.

Remarkably, in view of the further downgrade, IQE’s share price, which started 2018 at 137p and ended the year at 65p, has rallied to a current 83p. I put this down to management reassurances that 2019 will be the year of take-off.

IQE trades on a forward P/E of 26, which isn’t outrageous for a growth stock. However, given that 2018 forecasts were utterly decimated less than seven weeks from the company’s year-end, and also with some analysts having questioned its claims of technology leadership, I’m happy to avoid the stock at this stage.

Derating

This time last year, my Foolish colleague Roland Head saw a share price of 340p as a decent entry point for a long-term position in Morgan Advanced Materials. Earnings for 2018 were forecast to rise 12% to 24.2p a share, putting it on a P/E of 14, and with a prospective dividend yield of 3.4%.

In its results for the year, released today, the company reported a 17% increase in earnings to 26.7p and maintained its dividend at last year’s 11p level. The shares have rallied since a low of 246p in late December, but at 268p (little changed on today’s results) are still well below their level of a year ago. The P/E is now 10 and the dividend yield is 4.1%.

Overdone

Roland pointed out in his article that the company could be vulnerable to cyclical downturns in major industries. And it said today in its outlook for 2019: “We are likely to see slower growth in the key industrial economies in which we participate, and there are several macro-economic and geopolitical uncertainties which could have a significant impact.”

Nevertheless, on its current assessment of business trends and orders, management sees modest revenue growth for the year. Meanwhile, profit should increase more than revenue, due to planned efficiency savings. I think the market’s derating of the stock has been overdone and that it merits a ‘buy’ tag today.

Capital Gains

In the meantime, one of our top investing analysts has put together a free report called "A Top Growth Share From The Motley Fool", featuring a mid-cap firm enjoying strong growth that looks set to continue. To find out its name and why we like it for free, click here now!

G A Chester has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Apple. The Motley Fool UK has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool UK has recommended Morgan Advanced Materials. 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.