With a market capitalisation of only £275m at the time of writing, the firm is one of the market’s smaller companies.

Smaller companies tend to be riskier than large blue-chips because they lack the checks and balances that are in place at larger enterprises. These organisations may also find it harder to access financing in times of stress, leading to problems. 

However, these risks can be offset, to a certain extent, by the higher returns small-cap growth stocks can produce. And that’s why I would buy high-risk, high-reward growth stock RPS. 

Growth stock to buy 

I can see the risks of investing in this business clearly in its past share price performance. For example, at the beginning of February 2020, the stock was trading at 180p. However, by the end of March, shares in the company had fallen to 30p, a decline of 83%. 

Still, past performance should never be used as a guide to future potential. It looks to me as if this global professional services firm has tremendous potential as a growth stock. 

Revenues plunged last year as the coronavirus pandemic decimated RPS’s end markets. In the second quarter of 2020, fee revenue fell 18% year-on-year. That was the low point for the business. By the fourth quarter, the year-on-year decline had improved to just 12%. In the first quarter of 2021, fee revenue was £117.5m, just 8% lower than 2020’s figure. 

Based on this performance, management announced that the company expects to see revenue growth continue into the second quarter at the end of April. Profit margins are also expected to improve substantially.

The company also believes it is well-placed to benefit from the growing renewable energy market. Consulting revenue from RPS’s UK & Ireland business is already benefiting from a significant pipeline of carbon Net Zero and Data Centre projects.

Risks and challenges

Despite the company’s opportunities and growth potential, it faces significant risks and challenges as well. The pandemic has clearly had a substantial impact on growth. This suggests another global wave of coronavirus could hurt RPS’s recovery.

At the same time, consulting is an incredibly competitive market. RPS is a relatively small player in the sector, which could mean it misses out on large deals and has to spend more to compete with larger competitors. 

Despite these risks, I’m encouraged by the group’s recovery over the past 12 months. Therefore, I think this is a growth stock that I would be happy to buy for my portfolio. If RPS’s revenues and profits continue to improve and return to 2018/19 levels, the stock looks cheap. In 2018, the group earned nearly £30m after tax.

There’s no guarantee the company will return to this level of profitability, but I think this figure illustrates its potential. 

There must have been some unexpected bad news in today’s full-year results report. I’ll dig into that shortly, but first, here’s some background information.

Cyclical and vulnerable

First thing this morning, I ventured into the Motley Fool basement to find the archives on RPS. And after blowing off the dust, discovered my previous article on the company written on 14 July 2015 – years ago.

Back then, I was comparing the firm’s tempting-looking valuation with what at the time were the expensive valuations of a pair of defensive stalwarts – British American Tobacco (LSE: BATS) and Unilever.

However, in the article, I admitted that although RPS looked tempting, it’s a cyclical beast, and I said of the investment opportunity: “It could all go wrong if we really are just a spit away from macro-economic collapse!” 

And the firm has been demonstrating its cyclicality and vulnerability ever since. The share price has wiggled around, but there’s an unmistakeable down-trend on the chart and today’s 145p represents a decline of around 35% over the period.

Earnings have been volatile – up one year and down the next. And the shareholder dividend is now around 50% lower than it was five years ago. If you’d been holding the shares, you probably wish by now that you hadn’t.

Dire figures

Today’s figures aren’t pretty. Compared to the previous year, revenue slipped by almost 4%, fee income eased back just over 3%, adjusted diluted earnings per share plunged by almost 25%, and the total dividend for the year was cut off at the knees, plunging more than 55%.

Indeed, the company has rebased the dividend down to adopt a “sustainable dividend policy of paying out 40% of adjusted earnings.” Chief executive John Douglas said in the report: “We had to contend with several headwinds which significantly impacted on the results.” But looking forward, he reckons trading conditions in the company’s markets are “generally satisfactory” in 2020 and he anticipates more stable results.

But I’m not tempted to go near the stock. You’d have been better off investing in Unilever five years ago, which is up more than 60% since my previous article, despite its high valuation back then. Sometimes, quality companies can carry their rich earnings multiple.

Today, though, of the three companies mentioned here, I reckon British American Tobacco presents us with the most attractive opportunity. Over the past half-decade, the over-valuation has unwound and now BATS sits about 8% below where it was. But there’s been strong operational progress over the period with revenue, earnings cash flow and shareholder dividends all up.

I think today’s valuation is compelling with BATS, and the company is trading and growing well. My money would go into its shares right now to harvest its fat dividend.

However, I’m not prepared to take this distribution at face value. If we dig deeper into the numbers, it becomes clear that Centrica’s current dividend is living on borrowed time.

Cash crunch

A few weeks ago, City broker Jefferies said that Centrica’s dividend is “hanging by a thread,” as the company is struggling to deal with the whole selection of operational problems and volatile commodity prices.

According to the broker, Centrica’s earnings per share (EPS) could decline by 8% in 2019, based on current trends. This is the base case scenario. Jefferies goes on to say that if UK power prices fall a further 20%, the owner of British Gas would see its credit rating downgraded, increasing the cost of borrowing for the group, and possibly forcing management to sell-off the company’s nuclear business.

Personally, I wouldn’t invest in a business with such an uncertain outlook, and I think you should do the same. There’s very little good news around for the utility industry right now and, as Centrica’s dividend is only just covered by EPS, even a slight decline in profitability could force management to slash the payout. For this reason, I’m staying away.

Cash flow positive 

On the other hand, I’m more optimistic about the outlook for consultancy group RPS (LSE: RPS).

With a dividend yield of 7.1%, shares in this company immediately look attractive from an income perspective. What’s more, unlike Centrica, which operates in a heavily regulated industry, RPS doesn’t. So the business has more control over its future and isn’t subject to government energy price caps or volatile wholesale fuel prices.

RPS is also internationally diversified. Today, the company announced the acquisition of Corview, an Australian-based transport advisory consultancy for a total sum of £17.8m, payable in cash. Management hopes the deal will improve the group’s presence Down Under, and it seems to be a good fit for the business.

Alongside today’s acquisition announcement, RPS issued a trading update for full-year 2018. Trading is in line with City expectations, although slightly down on last year. Profit, before tax and amortisation, is predicted to be 7% lower year-on-year.

Still, despite this decline, cash generation remains strong. That’s why I’m interested because cash generation is generally a better predictor of dividend sustainability than earnings growth. According to my calculations, the company generated free cash flow of around £30m for 2018. That’s based on the fact that net debt fell approximately £8m during the year, and an assumed total dividend cost of £22m (based on 2017s figures).

These figures suggest to me that the firm has plenty of cash headroom to sustain its current dividend. Further, right now shares in RPS are dealing at an attractive forward P/E of just 8.8. I think this undemanding price is worth paying for RPS’s income potential.

Over the past 12 months, shares in the engineering conglomerate have slumped by 30%, underperforming the FTSE 100 by 22.5% excluding dividends. The sell-off has only accelerated over the past few months. Indeed, since mid-May, the stock has been off 40%.

But why are investors rushing for the exits, especially when Melrose has such an impressive record of producing returns for them?

Buy, improve, sell

Melrose is an expert at buying, improving and then selling underperforming engineering companies, like GKN, which the group finally acquired after a protracted takeover battle earlier in the year for £8bn.

Since its first acquisition in 2005, Melrose has delivered £4.8bn of value to investors using this strategy, and investors who bought in at the IPO have seen their investment grow at an average rate of 25% per annum over the past 13 years.

These are fantastic results, and I see no reason why Melrose’s experienced team cannot continue to churn out similar returns for investors going forward.

That being said, headwinds are growing for the group’s engineering businesses. Brexit and Trump’s trade war are both significant threats to Melrose’s enterprises. It would appear that these concerns are behind the recent sell-off.

However, this is not the first time management has had to contend with unfavorable operating conditions, and with this being the case, I believe now could be the time for savvy value investors to build a position in the stock. 

City analysts seem to agree. Over the past few months, 2018 earnings per share (EPS) estimates for 2018 have jumped 20%. As EPS estimates have gone up, and the share price has gone down, Melrose’s valuation has only gotten cheaper. Right now, the stock is changing hands for just 12.8 times forward earnings. 

In my mind, this valuation severely undervalues Melrose’s prospects, and that’s why I rate the stock a ‘buy’ today.

Troubled times 

Another growth stock that I believe is currently a ‘buy’ is RPS (LSE: RPS). 

Shares in this consultancy business have lost around a third of their value over the past six months. These declines have taken the stock down to a valuation of just 11.8 times forward earnings. There is also a 4.8% dividend yield or offer.

It seems that the market has soured on the RPS business because earnings are falling. The City was expecting the group to announce a 230% rebound in EPS for 2018, but today management has come out to confirm that fee income “will be marginally below market expectations,” while profit before tax and amortisation for the year will be “slightly below” 2017’s figure. 

Unfortunately, management also expects more of the same in 2019.

Time to buy? 

The firm’s downbeat outlook is disappointing, but I think it presents an exciting opportunity for patient investors.

RPS is struggling to grow because the group is investing heavily in its offering around the world. Over time these efforts should pay off, although they will hit earnings in the near term. However, I reckon that long-term holders won’t be disappointed when the growth comes through. 

As there’s also a 4.8% dividend yield on offer, investors are being paid to wait for a recovery.

But this scenario is not a surprise given the financial leviathan’s recent share price stampede — Standard Life’s stock value has advanced 16% over the past two months and hit two-year tops just shy of 450p late last week.

The company, which is due to merge with Aberdeen Asset Management imminently, announced today that assets under administration edged 1% higher between January and June to £361.9bn. This was despite the business enduring net outflows totalling £3.7bn in the period.

The asset manager saw fee-based revenues rise 5% in the first half, to £836m. And operating pre-tax profit advanced 6% year-on-year to £362m. “Standard Life has delivered a strong performance in the first half of 2017,” chief executive Keith Skeoch commented.

“We continue to see the benefits of targeted investments to further our diversification agenda, the success of our newer investment solutions and the ongoing focus on operational efficiency,” he added. “This has allowed us to grow assets, profits, cash flows and returns to shareholders.”

Merger adds extra star power

With the tie-up with Aberdeen Asset Management slated for completion in mid-August, Standard Life declared that “we are ready to accelerate the pace of strategic delivery as we open the next chapter of our transformation to a diversified world-class investment company.” The merger should give the enlarged entity greater scale and better diversification in what is an increasingly-competitive industry.

The City expects Standard Life to report earnings growth of 45% this year and 9% in 2018, resulting in a cheap forward P/E ratio of 14.9 times as well as a bargain PEG reading of 0.3. And the FTSE 100 giant also provides plenty for dividend chasers to shout about, the business sporting monster yields of 4.8% and 5.2% for this year and next.

Diversification pays off

I believe RPS Group (LSE: RPS) is another stock in great shape to deliver phenomenal long-term earnings expansion.

But investors need not wait for the company to deliver stonking growth, with City brokers predicting a 25% bottom-line rise in 2017. And a further 12% swell is anticipated for next year.

RPS Group, like Standard Life, has been no stranger to rampant investor demand in recent sessions either, the stock charging to three-year peaks around 280p late last week. Despite this the firm still deals on a very-reasonable P/E ratio of 15.8 times, while it also sports a mega-low PEG ratio of 0.6.

Investor faith in the Oxfordshire firm was rewarded last week when it spoke of a 35% uptick in pre-tax profit during January-June, at £27.2m. Despite ongoing pressure in the oil and gas industry, RPS Group’s efforts to diverse its operations are paying off handsomely. And I am confident ongoing progress in this area, allied with stringent cost management, should keep sending earnings skywards.

And half-year results released this morning bode well for income investors for several reasons. The first is that the interim payout was hiked from 4.66p to 4.8p year-on-year (y/y). The second is that management’s decision this time last year to halt acquisitions and focus on de-leveraging the balance sheet has worked well. The group’s net debt-to-EBITDA ratio has fallen from 2.2 times to 1.5 times y/y and management is now confident the balance sheet is healthy enough to increase dividends as well as to resume looking for suitable acquisitions.

With a resumption of the group’s acquisition-led growth policy, investors have good reason to expect rising earnings and eventually rising dividends in the near future. A return to buying up small consultancies in Europe, Australia and North America is also to be welcomed as it will allow the company to further reduce its dependence on the oil & gas sector. Management had already been doing this with all of its £124m spent between 2014 and 2016 on acquisitions directed to companies without direct exposure to oil & gas markets.

This strategy is already paying off as sales and profits returned to growth in H1 boosted by the weak pound and high activity from its property development and management businesses in the UK. With about 18% of fees in H1 coming from businesses in the oil, gas and Australian resources sector, RPS is still exposed to weakness in these markets. But with the balance sheet back in good shape, management looking forward to further acquisitions and a resumption of dividend payment growth, RPS could be a relatively safe way to gain exposure to these sectors for growth and income investors.

Too risky?

Another company with a solid history of dividend growth is agricultural products and engineering firm Carr’s Group (LSE: CARR), which from 2012 to 2016 increased dividends per share by 30% to 3.8p so that they now yield 2% annually.

Unfortunately, reliable dividend growth hasn’t been matched by stable earnings growth due to the cyclical nature of the agricultural bit of the business. As earnings from the agriculture division fluctuated based on dairy and raw material prices, they had an outsized effect on group results since they accounted for roughly 90% of revenue last year.

While the engineering division should be more reliable, it’s also not without its faults as a delayed contract caused a profit warning in March and led analysts to forecast a 20% fall in earnings for the current fiscal year. This contract has now been signed, but the delay will likely severely impact the already low group operating margins that were just 4% last year.

Stocks that are cyclical or very low-margin always make me apprehensive. The combination of both in Carr’s Group, together with a pricey valuation of 16 times forward earnings, will have me taking a hard pass on the company’s shares.

Impressive growth

Reporting on Thursday was infrastructure and support services company Stobart (LSE: STOB). It announced to the market that it is on track to deliver its targets of 2.5m passengers at London Southend airport and 2m tonnes of biomass supply annually, by the end of the 2018 calendar year. Further targets have been set to 2022, with the company well-positioned to continue to deliver improving operational performance.

Looking ahead, Stobart faces a somewhat uncertain future. Its CEO, Andrew Tinkler, is stepping down but will remain as an Executive Director. As with any company, this inevitably brings a degree of risk and uncertainty, but since the business seems to have a solid strategy this may not cause significant disruption.

With the company trading on a price-to-earnings (P/E) ratio of 37, it appears to be overvalued at the present time. However, since it is expected to report a rise in earnings of 171% in the next financial year, its price-to-earnings growth (PEG) ratio of 0.2 suggests it could offer upside potential. While the company has ambitious growth targets and is undergoing a period of major change, it seems to have a sufficiently wide margin of safety to merit investment for the long term.

Solid outlook

Also offering capital growth potential is international consultancy company, RPS Group (LSE: RPS). It is forecast to record a rise in its bottom line of 9% in the next financial year. This is ahead of the growth rate of the wider index, and means it has a PEG ratio of 1.5. This could be relatively low considering the company’s track record of growth, as well as its long-term strategy which seems to be progressing well according to its most recent update.

As with Stobart, RPS is about to change its CEO. Its valuation indicates there is a margin of safety on offer, while its income potential means it could become more popular among investors. That’s especially the case since inflation is forecast to rise from its already high level of 2.9%.

RPS currently yields 3.9% from a dividend which is covered 1.7 times by profit. This means it could raise shareholder payouts at a faster pace than profit growth without harming its scope to reinvest capital for future growth. A rising dividend also seems affordable even with the company’s acquisition programme factored-in. According to its most recent update it is seeking to engage in M&A activity, which could act as a positive catalyst on its financial performance.

I rate RPS a ‘buy’ but could fellow small cap Autins (LSE: AUTG), whose shares plummeted 30% yesterday after unexpected bad news, offer even better value?

Improving performance

RPS has been through a tough time. Although its activities are spread across a range of sectors, including the management of water resources, urban design and transport planning, it also has significant exposure to oil and gas, both in consultancy and operations.

The first half of 2016 saw group profit before tax and amortisation (PBTA) — excluding exceptional items — falling 30% to £20.2m from £28.8m. This followed on from a 22% decline in 2015, which also saw a £20m impairment of assets due to the oil and gas downturn and a provision of £7m for doubtful debts.

The good news today is that a significant proportion of the doubtful debt has been recovered, resulting in a reversal of provisions totalling £4.2m. Moreover, the company said that even excluding this provision reversal, the full-year result is “still well above current market expectations”. In fact, second-half trading has been so good that despite the 30% fall in H1 PBTA to £20.2m, the full-year number will be close to last year’s £51.8m.

Trading at about 16 times earnings and with the board intending to maintain the dividend, giving a yield of 3.7%, I reckon RPS could be a strong performer as the oil and gas outlook improves.

Revenue warning

AIM IPOs often disappoint, but even by the usual standards, Autins is a shocker. The company, which supplies insulation products to the car industry, listed on AIM just five months ago with a placing of 15.8m shares at 168p. Of these, 7.5m were existing shareholders selling out.

Yesterday, Autins announced that chief executive Jim Griffin — who pocketed over £2m selling shares in the IPO — “has, for personal reasons, resigned … with immediate effect”.

The company also announced that, while its results for the year ended 30 September 2016 will be in line with market expectations, it “is now aware that a major customer has provided revised volumes and introduction timings for certain platforms”. As a result, the board expects revenues for the current year to be “materially lower than market expectations” and is also evaluating the likely impact on the year to 30 September 2018.

Autins hasn’t given any numbers but the AIM Admission Document told us that 58% of the group’s 2015 revenue came from one key customer (Jaguar Land Rover) and that if “any of its key customers” terminated or significantly reduced business with the company, “its results of operations and/or its financial condition could be materially adversely affected”.

Ahead of yesterday’s grim news, the house broker had been forecasting revenue of £33.5m and profit of about £3.3m for fiscal 2017. At a current share price of 150p, the company’s market cap is £33.2m. That looks too high to me, given that the pre-revenue-warning forecasts are going to be materially lower. As such, I have to rate the shares a ‘sell’.

Sales from Hikma’s generics division were below expectations during the first half of the year. Although full-year generics revenue is still expected to be within previous guidance of $640m-$670m, profits will be substantially lower.

Hikma said on Wednesday that core operating profit from Generics for the full year is now expected to be $30m-$40m. This implies a core operating margin of about 5%.

The firm’s previous guidance in May was for a core operating margin “in the low double-digits”. Based on last year’s core operating profit of $409m, my calculations suggest this means Hikma’s core operating profit will fall by about 10% this year.

I expect analysts to reduce their full-year forecasts based on this new guidance. With the shares trading on about 26 times earnings, Hikma looks a little too expensive for me.

A 74% profit drop looks bad

Adjusted pre-tax profits at mechanical parts group Brammer (LSE: BRAM) fell by 65% to £5m during the first half of 2016. The slump in profits came despite sales remaining almost unchanged, at £372.3m.

Brammer shares only fell by around 6% following today’s results. Most of the bad news was already in the price after June’s profit warning, which triggered a stunning 56% collapse. Indeed, since hitting a low of 57p at the end of June, Brammer shares have climbed 40% to 87p.

Brammer’s rapid expansion seems to have coincided with falling sales. The firm said this morning that sales per working day fell by 3% during the first half of the year. Sales in the Nordic region and the UK were hardest hit, thanks to the oil market downturn.

The company is now dangerously close to breaching its lending covenants and has suspended dividend payments. Stock levels are being reduced to generate cash and the group’s new chief executive, Meinie Oldersma, is leading a strategic review.

Although Brammer could be an interesting turnaround, I suspect a rights issue may be necessary to reduce debt. I plan to wait for further news before considering an investment.

Another oil casualty?

Consulting firm RPS Group (LSE: RPS) works with customers in the construction, energy and environmental sectors, but the oil market is a key element of the mix.

RPS shares fell by 8% this morning after the firm said that adjusted pre-tax profits fell by 29% to £20.2m during the first half of the year. The firm said it would freeze the interim dividend at 4.66p and would adopt a more cautious approach to acquisitions until conditions improve.

The group’s energy business slumped to a loss of £0.9m during the first half of this year, compared to a profit of £9.6m in 2015. Rising profits elsewhere in the business weren’t enough to offset this big fall.

Acquisition activity meant that net debt rose from £79m to £95m. Although RPS has plenty of headroom left on its lending facilities, this does concern me. With the shares trading on around 14 times forecast earnings and the 5% dividend yield under pressure, I think it’s too soon to buy.

There are three main reasons for the disappointing performance this time around. The first is operational issues in the Wireless business which have resulted in delayed shipments and a one-off charge of £9m. The second is increasing headwinds in the commercial fly-in fly-out business. And the third reason is cost increases in a small number of development programmes in the Advanced Electronics Solutions Sector.

Even though the rest of the company is trading in line with expectations, the impact on earnings of the overall business means that Cobham’s leverage could be close to the net debt-to-EBITDA covenant ratio of 3.5 times at 30 June 2016. As a result of this, Cobham is seeking to raise £500m so as to reduce net debt to EBITDA to around 2 times.

While Cobham is clearly experiencing a very challenging period and its shares are likely to remain volatile in the short run, it remains a high quality business. Therefore, today’s share price fall could present an opportunity for any long-term investors who are able to live with an above-average degree of volatility in order to buy-in at a relatively low price. And with the outlook for the wider defence sector being upbeat, Cobham could prove to be a sound purchase at the present time.

Falling profits

Also falling by up to 20% today are shares in RPS Group (LSE: RPS). As with Cobham, it has released a profit warning today, with it expecting profit for 2016 to be lower than in 2015. The key reason for this is weakness in the oil and gas sector, with many of RPS’s customers announcing cuts to capital expenditure. This has affected RPS’s level of new commissions in its energy business in particular. In response it’s continuing to reduce its cost base, with 14% of staff being made redundant in the current year.

Clearly, this is a difficult period for RPS and further pain in the short run can’t be ruled out. However, cost-cutting measures seem to be an appropriate step to take, as does the acquisition of DBK for £13m. It’s a project management consultancy and should help to further diversify RPS away from the oil and gas sector. However, recent rises in the oil price could be beneficial to RPS and with it being a high quality business despite its current problems, it could be worth buying for investors who are able to take a long-term view.