I’m looking to make some investments in September. And while I think that there are a number of decent investment opportunities at the moment, I’ve identified two strong buy stocks for my portfolio this month.
The stocks in question are Diploma (LSE:DPLM) and Experian (LSE:EXPN). I don’t own Diploma shares yet, but I do own Experian. Here’s why I’m looking to add one to my portfolio and increase my investment in the other.
Recession
It looks to me as though the UK is heading for a recession. Energy costs are rising, inflation is high, and the Bank of England’s best attempts at stemming the tide don’t seem to be working.
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As a result, I’m expecting things to get worse before they get better and looking to be cautious in my investing at the moment. For me, that means two things.
First, it involves focusing even more carefully than usual on high-quality businesses when I’m looking for stocks to buy. In an unhelpful macroeconomic environment, I don’t want to be taking unnecessary risks.
Second, it involves being especially conservative in valuing stocks. That means being realistic in estimating what the underlying businesses will produce in the future and working out how much I’m prepared to pay accordingly.
Quality
At first sight, it’s hard to see how Diploma and Experian fit the bill. Both of the stocks look like they have optimistic growth assumptions built in.
Diploma currently trades at a price-to-earnings (P/E) ratio of around 41. Experian looks a bit more reasonable at 24 times earnings, but it still looks risky.
Beneath the surface, though, there’s a lot more going on. Both companies have exceptional cash conversion ratios and I think this makes them attractive stocks at current prices.
Diploma converts just over 92.5% of its operating income to free cash. Experian is even better – over 94% of its operating income becomes free cash flow.
This is extremely impressive. For context, both of these numbers are more impressive than Alphabet (84%), Apple (89%), and Meta Platforms (91%).
According to Warren Buffett, the value of a business is a function of the cash it will produce. And I think that both Diploma and Experian generate enough cash to offset the risk implicit in their respective P/E ratios.
Valuations
With interest rates forecast to reach 4% next year, I’m looking for an expected return of 7% per year from a stock investment.
For Diploma to achieve this, its earnings per share need to increase by around 15% annually. That seems like a lot, but I think that the company has a lot of opportunities ahead of it and a management team that is able to take advantage of them in intelligent ways.
In the case of Experian, the business needs to grow at an average of 12% annually for the next decade. Since it’s been growing at closer to 15% over the last 10 years, I believe that this is achievable.
That’s why I think that both Diploma and Experian are strong buy stocks for me at the moment. I’d be happy adding shares of either to my portfolio at today’s prices.
