With stock markets trading close to record highs, I believe it’s important to be selective when investing fresh cash into the market.
Today I’m looking at two stocks I believe are still reasonably valued. In my view, both of these companies have the potential to outperform the market over the next few years. If you’re in the early stages of building a stock portfolio, they might be worth considering.
My first stock is FTSE 100 plumbing and heating group Ferguson (LSE: FERG), which was known until recently as Wolseley.
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The name change is the result of the company’s decision to focus on its US business, which now accounts for roughly 80% of both sales and profits. Growth is much stronger across the pond too. Ferguson’s sales rose by 10% in the US last year, compared to just 0.8% in the UK.
Still small enough to grow
Despite a market cap of £13.5bn, I believe Ferguson is still small enough to deliver strong growth. The US construction market appears to be in good health, giving larger suppliers such as Ferguson the opportunity to expand their share of the market.
One part of this strategy involves the acquisition of smaller, specialist firms. By doing this Ferguson is expanding its product range without taking on too much debt. Indeed, the firm’s strong cash generation and low debt level are key attractions for me.
City analysts expect the firm’s adjusted earnings to rise by about 13% to 324.1p per share this year. The dividend is expected to rise by 13%, to 124.4p. These projections put the stock on a forward P/E of 16.8, with a potential dividend yield of 2.3%. In my view this could be a profitable level at which to buy.
Smaller and more exciting?
If you’re also interested in smaller companies, then you may be interested in my second pick. Recruitment group SThree (LSE: STHR) operates globally and specialises in the STEM industries — science, technology, engineering and mathematics.
Demand for specialists in these fields may vary as economic conditions change, but in my opinion demand for STEM professionals is only really likely to rise over the coming years. Meanwhile, the firm’s global focus should provide some protection against the risk of a slowdown here in the UK.
In my view, these factors help to make SThree one of the top picks in the recruitment sector.
A profitable year
The firm published its annual results last week, for the year to 30 November. These figures looked good to me. Revenue rose by 16% last year, while adjusted pre-tax profit rose by 9% to £44.5m.
Although profit margins are generally low in the recruitment sector, the group’s return on capital employed — a measure of profits relative to the assets of the business — is well above average, at 46%. This is generally a good quality signal and an indicator of a company’s ability to generate surplus cash from its activities.
City analysts are expecting earnings growth of 10%-15% per year over the next two years. These projections give the stock a forecast P/E of 13 for 2018, falling to a P/E of 11.2 for 2019. In my view this is potentially an attractive entry point, especially as the shares also offer a well-supported 4% dividend yield.
