If I were to ask you to name a handful of growth stocks, what would you choose?
A couple of technology stocks? Mining stocks? Financials?
All good choices, I accept, but there is a growth stock lurking among the Industrials industry group in the FTSE 100 that you may not really have thought of as offering above-average growth prospects.
That company is Rolls Royce (LSE: RR) (NASDAYOTH: RYCEY.US) and, although your first reaction may be to consider it a slow and steady manufacturer of aircraft engines, in actual fact it offers well above-average earnings growth rates.
Indeed, Rolls Royce is forecast to increase earnings per share (EPS) by 12% this year and by 9% the year after. This is well above the FTSE 100 average of mid single digits and, moreover, when the earnings growth rate is combined with a price to earnings (P/E) ratio of 18, it generates a price to earnings growth ratio of 1.7.
Of course, this is considerably above the PEG sweet spot of 1.0. However, it sits considerably below the PEG ratio of the FTSE 100, where a P/E of 13.8 and mid single digit earnings growth (on average) mean the PEG ratio is north of 2.
Furthermore, if Rolls Royce were to trade on a PEG ratio in between its current level and that of the wider market, it would mean a PEG ratio of 2.0 and a share price of 1,390p. This is 200p (or 16.8%) above its current share price and shows that shares could have considerable upside potential, even if they still trade on a discount to the market PEG ratio.
The one downside with Rolls Royce is a relatively low dividend yield, with shares currently yielding just 1.8 % (well below the FTSE 100 yield of 3.5%). This could make total returns of 20%+ achievable over the medium to long term, but the portion from capital gains is still likely to make up the vast majority of any future return.
A below average yield, though, should not put you off Rolls Royce as it seems as though gains of around 20% could be on offer.