Gamma Communications’ (LSE: GAMA) share price is on a tear at the moment. Over the last year, it’s risen about 50%. A lot of City analysts expect the British communications company’s stock to continue rising however.
One major brokerage firm even thinks Gamma’s stock could climb another 48% from here in the medium term.
Lofty price target
The brokerage firm I’m referring to is Deutsche Bank and it currently has a price target of 2,250p on Gamma shares.
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That target – which is currently the highest within the brokerage community – is about 48% more than the share price today (1,520p, as I write this).
So if the stock was to hit that target, a £1,000 investment today would grow to around £1,480 (note that I’m ignoring trading commissions and platform fees here).
I’m bullish
Now, I own Gamma shares in my portfolio. And I’m pretty bullish on them. This company’s growing at an impressive rate as organisations rush to get their communications systems up to speed for the digital age. This year, for example, revenue is forecast to rise nearly 9%.
It’s also seeing its earnings rise sharply. Currently, analysts expect earnings growth of 7.9% this year and 8.8% next year.
I’m not convinced that the growth here is fully reflected in the company’s valuation however. At present, the forward-looking price-to-earnings (P/E) ratio using next year’s earnings per share (EPS) forecast of 88.1p is 17.3.
That strikes me as quite low. Especially considering that Gamma has pretty much no debt on its balance, consistently generates a high return on capital (five-year average of 23%), regularly increases its dividend, and does share buybacks (the group announced a £35m buyback in March).
Given the level of quality here, I think this stock deserves to be trading on a P/E ratio of around 20-25. If the P/E ratio was to rise to 25, we’d be looking at a share price of around 2,200p (using next year’s EPS forecast), which is pretty close to Deutsche Bank’s target of 2,250p.
No guarantees
Now of course, while Gamma shares are in a strong uptrend today, there’s no guarantee that they’ll hit 2,250p any time soon.
If the company was to announce a slowdown in growth as a result of weak economic conditions in its upcoming half-year results (these will be posted in early September), the shares could nosedive.
Another risk is a general stock market wobble. If volatility was to return to the markets, this company – which is still relatively small – could see its share price fall.
Taking a long-term view however, I think this under-the-radar growth stock has a lot of potential. In my view, it’s a great play on the ongoing digital transformation theme.
