An incredibly cheap growth and dividend stock to consider now

Normally, when I see City analysts predicting forward earnings growth of 16% I don’t expect to see the forward price-to-earnings ratio of a company to be as low as nine.

However, that’s what we are seeing with RM (LSE: RM) right now, so is something wrong or is this share a bargain?

In line with expectations

The company provides educational resources, IT services and software to the education sector, and updated the market on progress on 22 March. Trading in the current year is down more than expected, according to the firm’s chairman John Poulter. Schools are being cautious with expenditure due to uncertainty over their funding and because staff costs rose this year, he reckons. One bright spot is that first-quarter trading in RM’s international business “continues its positive trend.”

Overall, the directors think full-year trading will come in as expected, which means a flat result on earnings for the year to November 2017 and 16% growth the year after that. Last year, around 20% of revenue came from outside the UK. So even though international trading is going well, I don’t think the 80% of trade coming from the UK can be dragging too hard on the firm’s results. Otherwise, City analysts’ forecasts would be bleaker. Meanwhile, the forecast growth in earnings for 2018 suggests the directors expect UK trading to bounce back.

So, a soft patch of trading in the UK this year and a positive outlook beyond that does not explain the low valuation. Even the forward dividend yield looks attractive running at just under 3.8% for 2018, with the anticipated payout covered three times by forward earnings – a high-looking level of cover suggesting the directors see opportunities to reinvest cash inflow for growth from here. Indeed, they expressed their confidence in RM’s future by hiking the final dividend for 2016 by more than 20% compared to the year before.

The elephant in the room?

There must be something wrong, and there is. It seems that the cash the firm generates from operations is all being gobbled up by the pension deficit. However, if that’s the issue holding the shares back, it could be disguising opportunity for investors.

With the full-year results for 2016, RM said the pension deficit increased “to £34.8m (2015: £21.9m) as liabilities have been impacted by lower market discount rates.” Of the just over £13m of cash from operations RM generated during the year, almost £12m went as a cash contribution to the defined benefit pension scheme. That’s a 200% increase over the £4m or so the firm threw at the pension the year before.

Nevertheless, RM is trading well, generating lots of cash, and ended 2016 with zero debt and a £40m cash pile on its balance sheet. The shares seem to be trending up and there’s no sign that the directors are scaling back their organic and acquisitive growth ambitions. RM could be well worth your further research. I think the low valuation compensates for the pension issue and a valuation re-rating could power investor returns from here as 2017 unfolds, as long as funding holds up in the education market.