Today, I’m looking at 3 undervalued growth stocks.
Duopoly
Until recently, Rolls-Royce (LSE: RR) had been one of the FTSE’s greatest growth stories. In the 10 years leading up to December 2014, the value of the engine maker’s shares gained more than 600%. The shares have since fallen by 48%, and currently stand at 650p.
Rolls-Royce is facing a very difficult trading environment. Its top line is shrinking because of a compbination of cuts to defence spending and low energy prices, while the launch of its new Trent 7000 commercial wide-body engine is driving costs higher and lowering operating margins.
While short term trends are clearly challenging, long term fundamentals are firmly in the company’s favour. With huge order backlogs at aircraft makers Airbus and Boeing, demand for engines should continue to be buoyant. What’s more, Rolls-Royce is one of only two firms in the world that manufactures wide-body aircraft engines. And in a duopoly market, firms can sustain high levels of profitability and wide margins from their strong competitive positions.
A sharp fall in earnings is forecast for 2016, putting its shares on a forward P/E of 25.4. The dividend has been cut by half, which leaves its shares trading at a prospective yield of just 1.4%. With a pricey P/E valuation and a low yield, that doesn’t leave much to be desired. But, given that long term fundamentals are intact, Rolls-Royce is an attractive turnaround play.
Outperform
Fears over a slowdown in Asian emerging markets have caused shares in Prudential (LSE: PRU) to fall by 24% over the past 52 weeks. Slower growth in Asia will undoubtedly create headwinds for the insurer, but long term trends remain intact. Low levels of insurance cover and a growing middle class in Asia are supportive of continued out-performance by emerging market focussed insurers, even as economic growth slows.
In the meantime, investors can look forward to the Pru’s prospective dividend of 42.8p per share this year, which gives it a yield of 3.4%. With the payout ratio expected to be remain below 40% in 2016, there is also plenty of scope for continued dividend growth over the next few years.
5.6% Yield
Standard Life (LSE: SL) sees itself as more of an investment manager rather than a life insurer these days. In recent years, the company has been moving away from its life insurance and has focussed heavily expanding on its asset management business.
A rise in stock market volatility and poor investor sentiment have hurt shares in investment managers, but I think Standard Life will fare much better than its rivals. Standard Life’s focus on lower volatility funds and its greater reliance on institutional client funds should mean it will continue to be able to grow assets under administration, while on its life insurance side of the business, its limited exposure to annuities should mean it will be less affected by pension changes that came into force in April 2015.
Its share price is a third lower from its 52-week high of nearly 500p, which could mean this may be an attractive entry point for investors who expect more growth is yet to come. Standard Life trades at a forward P/E of 13.0 and carries a prospective dividend yield of 5.6%.