Today I’m looking at two stocks which I believe could offer a rewarding mix of income and growth for new investors. Both stocks look reasonably priced to me, with good growth prospects.
A stronger position
Many industrial firms depend on specialist manufacturers to produce the components they need. Materials engineering specialist Morgan Advanced Materials (LSE: MGAM) is one of these firms, producing high-specification ceramic and electrical parts for use in markets including healthcare, electronics and oil and gas.
The group has been through a series of changes over the last few years, but today’s full-year results confirm that this process is complete and that the company is returning to growth.
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Sales rose by 3.3% to £1,021.5m last year, while headline operating profit was 2.4% higher, at £119.7m. These figures give a respectable headline operating margin of 11.7%, broadly unchanged from 11.8% in 2016.
A return to growth?
Income investors may be slightly disappointed that the dividend has been held flat, at 11p per share. A flat dividend sometimes suggests that the payout is becoming unaffordable, but I don’t think that’s the case here.
Last year’s headline earnings of 22.5p covered the 11p per share payout dividend twice. The dividend was also covered by the group’s underlying free cash flow of £54m. I suspect that the board’s priority was to direct surplus cash towards debt reduction before raising the dividend.
The group’s net debt fell by 25% to £181.3m last year. This reduced the group’s borrowing multiple to 1.2 times earnings before interest, tax, depreciation and amortisation (EBITDA) — a fairly comfortable level.
Looking ahead, Morgan Advanced Materials looks well positioned for a return to growth. Adjusted earnings are expected to rise by 12% to 24.2p per share this year and a dividend hike of 2% has been pencilled in by analysts.
These forecasts put the stock on a 2018 P/E of 14, with a prospective yield of 3.4%. In my view, this could be a decent entry point for a long-term position.
One stock I’d hold forever
Morgan Advanced Materials could be vulnerable to cyclical downturns in major industries. I believe my next stock, Smiths Group (LSE: SMIN), may have a more defensive business.
This conglomerate owns a number of companies, but its two biggest divisions are Smiths Medical and Smiths Detection, both of which operate in fairly defensive markets.
Smiths Medical makes a wide range of devices, 82% of which are consumable and disposable, so generate a high level of repeat orders. Smiths Detection makes equipment such as airport security scanners. I expect demand for such equipment to continue rising and this business also generates a high level of after-market support work.
These two divisions generated 50% of group revenue and about 53% of headline operating profit last year, providing solid support for other parts of the business with greater cyclical exposure.
A stock to buy and hold
In my opinion, Smiths Group is a high quality business, with attractive long-term growth potential. The group generated a return on capital employed of 16% last year and an operating margin of 20%. Both of these figures are well above average.
Earnings are expected to grow by around 10% per year in 2018 and 2019. The shares currently trade on a forecast P/E of 16 with a prospective yield of 2.8%. I think this is a fair price for a good business and rate the stock as a buy.
