Three stocks with plenty of growth potential

Each week, a professional investor tells MoneyWeek where he’d put his money now. This week: Mark Slater, manager of the MFM Slater Growth Fund and CIO at Slater Investments.

Companies able to deliver reliable, above-average earnings growth are rare, especially while deleveraging and government retrenchment hang over the economy.

We therefore seek to invest in firms trading on low PEG ratios – a low price/earnings ratio in relation to the earnings growth rate. Further, earnings need to be backed by strong cash flow. Our ideal investments are businesses operating in growing markets or niches with strong market positions. We also like to see a meaningful management shareholding.

One of the MFM Slater Growth Fund’s major investments is Education Development International (LSE: EDD). The company provides certification for UK government-approved vocational qualifications. It also offers international business qualifications under the London Chamber of Commerce brand. Despite some uncertainty over the detail of the new government’s training policy, apprenticeships and youth training remain priorities. This high-margin business is well positioned and winning market share. It managed to grow during the uncertain months immediately before the election, building on the dramatic growth of the 2008-9 financial year. With first class management and net cash equivalent to 15% of the market capitalisation, a PEG of 0.5 (based on a p/e of 8.5 and a 16% growth rate) is far too low.

Another relatively recent purchase is Hutchison China MediTech (LSE: HCM). HCM has several activities, but the one that appeals most is its Chinese healthcare operation. The company is a strong player in over-the-counter and prescription traditional Chinese medicine with market-leading products and a broad sales and distribution network. The healthcare business has grown its revenues at 29% compound for the last five years. Last year’s 26% revenue growth translated into 43% growth in operating profits. We expect continued strong growth in sales and profits for many years to come. Ignoring any of HCM’s other operations, the current market capitalisation values the healthcare business on a forward p/e of 17.5. That’s low in relation to its rapid growth rate and relative to pharma p/e multiples in Hong Kong and mainland China. However, HCM’s other operations are also valuable: it owns one of China’s leading drug R&D businesses which is likely to be floated on Nasdaq in the next year or two. The company’s organic foods joint venture also promises to become a very significant contributor to profits.

Another favourite is Cape (LSE: CIU), which provides access, insulation, fire protection and other essential services to the energy and natural resources sectors. The company is highly cash generative, has a net debt to earnings before interest, tax, depreciation and amortisation (ebitda) ratio of only 0.8 and boasts leading positions in the fast growing Gulf, Far East and Pacific Rim regions. During the crisis Cape’s revenues were extremely robust, being based on multi-year maintenance contracts with blue chip customers. After several strong years, 2010 is likely to be a year of consolidation with modest earnings growth. However, Cape expects very large contract wins in the second half of 2010 which will benefit the company in 2011, underwriting a return to rapid growth for that year and beyond. Trading on a p/e of five, but with 15% growth (perhaps more) in prospect, the shares are very attractive.


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