Today, I’m taking a look at two growth stocks I believe have the potential to beat the market.
Favourable tailwinds
First up is Ashtead Group (LSE: AHT). The international equipment rental company is benefiting from favourable tailwinds as a weak pound and improving US construction activity underpin expectations of continued earnings growth.
As the US market accounts for more than 80% of the group’s revenues, Ashtead has much to gain from the country’s improving economic outlook. And in addition to cyclical tailwinds, the group’s growth prospects are also bolstered by structural factors, such as the chronic underinvestment in critical infrastructure over past decades, which has created an urgent need to repair, renovate and replace its roads, bridges, and other infrastructure projects.
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As expected, given the nature of the business, its rental operations are extremely cash generative and this has meant its dividend has been covered comfortably by free cash flow. And although the stock has a prospective yield of just 1.9% for the current year, I reckon there’s plenty of scope for dividend growth given that the forecast payout ratio is just over 25%.
Two reasons
There are two reasons for why I prefer Ashtead to others in the sector. First, the company has a great earnings track record, which demonstrates the robustness and resilience of its business model.
Over the past five years, underlying earnings per share grew by a compound annual growth rate (CAGR) of 44.6%. And looking ahead, City analysts expect the group to continue to grow earnings in double-digit percentage terms, albeit somewhat more modestly, with forecasts of underlying EPS growth of 15% this year, and 11% in 2018.
Second, the company’s size gives it a significant competitive advantage. Its larger scale allows it to spread overhead costs more broadly and helps it to negotiate better prices with suppliers. This has enabled it to deliver EBITDA margins of almost 50% and produce returns on investment ahead of its peers.
With a forward P/E of 13.4, the stock may not be as cheap as some in the sector. However, it’s valuation doesn’t seem too demanding given that the average FTSE 100 company trades at 14.6 times their expected earnings this year.
Growing order book
Also offering upbeat growth potential is Morgan Sindall (LSE: MGNS). Business at the construction and infrastructure group is booming as growth from regeneration projects drives its order backlog higher. At the end of last year, its order book rose 29% to £3.6bn, while adjusted operating profits increased 26% to £48.8m.
The group has been making good progress on its development portfolio to regenerate town centres and has a strong visible pipeline of future regeneration opportunities. Morgan Sindall is also targeting improved operational performance as it continues with its cost reduction focus, particularly for its new contracts.
The stock looks affordable to me. City analysts forecast adjusted earnings of 97.4p per share this year, putting the stock on a forward P/E of 12.7. What’s more, investors could look forward to an expected 14% dividend hike this year, which would push the payout up to 40p a share and give it a prospective yield of 3.2%.
