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Go for growth!

Created:
23 May 2008
Written by:
Dominic Picarda

Nothing tends to capture investors' imagination as much as growth does. The thought of buying into the next big thing before it actually becomes the next big thing is very alluring indeed. Had we, for example, bought into Microsoft in its early days, then we'd probably be sitting on our yachts in the Caribbean today.

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Daydreaming aside, growth is a hugely important theme in picking shares, even if you don't think of yourself as a "growth investor". Over time, a rising dividend requires rising earnings. So a company's ability to increase its sales and expand its market share is a key consideration in analysis.

Of course, we need to recognise the difference between a growth company and a growth share. A company's business may have excellent growth prospects, but its shares may have relatively little growth potential, particularly if its bright future is already reflected in its price.

In other words, it is possible to identify growth shares that don't have growth – that is, very high – valuations. This approach to investment is known as "growth at a reasonable price" or GARP. Let's see how our surviving nine shares measure up.

Aero Inventory

Thanks to large contracts with Australia's Qantas and Canada's ACTS, stockbroker Charles Stanley expects Aero Inventory's revenue to have jumped 78 per cent in the year to June, with cash profits up 71 per cent.

The group now has maintenance and repair customers in each main geographic area, so Charles Stanley believes it will focus on targeting airline customers – it recently won a smaller contract with Japan’s All Nippon Airways. In the longer term, the broker expects sales to non-contracted third parties to increase significantly from a small base.

BAE Systems

The Ministry of Defence has been given a long-awaited go-ahead for a £3.2bn contract for two aircraft carriers. This is just the latest deal to be added to BAE Systems' already bulging order book of about £39bn. Defence spending is also on the increase, particularly in the US, where BAE has an expanding presence following a number of key acquisitions, such as last year’s purchase of Armor Holdings.

Numis Securities believes BAE's Saudi Arabia-related business could double over the next five years. The group is also keen to tap into the defence needs of India, South Korea and Japan.

BG

The recent discovery of an oilfield off the coast of Rio de Janeiro by BG's Brazilian partner Petrobras has stoked up huge excitement over the company's prospects. Although BG has sensibly distanced itself from premature speculation, the Carioca field clearly has the potential to add significantly to its already vast reserves portfolio. Its liquefied natural gas (LNG) business is also soaring thanks to booming global demand. The delivery of four new LNG ships helped grow volumes by 31 per cent and enabled BG to supply nine countries in 2007, and two more ships are on order.

BHP Billiton

Already the world's largest resources group, BHP Billiton could soon become even bigger still. If it succeeds in taking over rival Rio Tinto, its earnings and cash flow are forecast to benefit from the first full year, which would offer shareholders an opportunity to participate in the proposed initial share buy-back of up to $30bn (£15.25bn). Putting the deals aside, BHP still represents a world-class collection of assets and projects in waiting. Demand from developing economies promises to fuel demand for basic materials for many years to come.

Capita

Having increased earnings at a compound yearly rate of 22 per cent over the past five years, Capita's prospects still look great, despite the worsening economic outlook. With both companies and public bodies under pressure to cut costs, more and more are likely to turn to Capita for assistance. Its business-process outsourcing operation is forecast to expand at about 10 per cent a year. Brokers’ forecasts of double-digit earnings growth for Capita are underpinned by its £2.5bn order book. What's more, it has a great record of bolstering its organic expansion by buying out smaller rivals.

Dignity

Unless Britain succumbs to a pandemic, funeral-parlour owner Dignity is never going to report a dramatic surge in growth. The number of deaths each year in the UK is fairly predictable, so the company's progress comes from making more money from each funeral and buying up family-owned funeral businesses. Taking over council-run crematoria offers another expansion possibility, but the company has not yet made as many advances here as it would have liked. There is little prospect of branching out overseas, as the funeral business is very different from nation to nation. Still, while Dignity's growth prospects are limited, they are consistent.

Shire

Thanks to its new attention deficit hyperactivity disorder drug, Vyvanse, Shire's earnings over the next five years are set to take off. According to analysts at stockbroker Collins Stewart, post-tax profits are likely to grow 18 per cent a year for the next five years. Vyvanse’s has key advantages over AdderallXR, Shire’s blockbuster product of recent years. It is safer and only needs to be taken once daily, rather than twice. Trading on a one-year forward earnings multiple of 14.5 times, this tremendous growth is arguably not reflected in the price of Shire's shares.

SIG

Eighteen acquisitions already completed this year are forecast to add £174m to SIG’s annual sales. Thanks to its healthy cash generation, SIG is well able to fund this acquisitive policy. For while operating profits in 2007 rose from £109.8m to £130.3m, cash inflow from operating activities jumped from £132.4m to £160.3m. True, acquisitions have increased gearing from 65 per cent to 75 per cent, but fresh funds were raised through a £147m share placing as well as a further £100m of lending secured. And shareholders are already enjoying the benefits, with SIG increasing the dividend payout by 30.2 per cent

Unite

Already the runaway market leader in the student-accommodation market, Unite's capacity is increasing by 3,500 bed spaces a year. Following the launch of its online accommodation management system last year, forward sales are up nicely, with 77 per cent of 2008-09 places already reserved. What's more this expansion should be fairly reliable, as higher education is viewed as a necessity rather than a luxury nowadays. Unite also hopes to exploit its customer base through the launch of Liv-o-city, offering recent graduate workers studio flats to rent in central London.

VOTE NOW!

You can vote on the Share Champions microsite, where you'll also find our experts' views on how are remaining candidates shape up.

Voting for this test closes on Tuesday evening, and we'll announce the next company to be ejected on the website on Wednesday. Details of the next test will appear next week.

The result of the last test - intuitive appeal - was that Whitbread was voted off.

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by Dominic Picarda