While the FTSE 100’s new record high inevitably means valuations are likely to be somewhat generous, there are a number of stocks which still appear to be undervalued. In some cases, this could be due to disappointing outlooks, or troubled past performance. However, in other cases it appears difficult to justify low valuations among large and mid-cap shares. Here are two examples of companies which could be worth far more than their current valuations, given their upbeat growth outlooks.
Reporting on Monday was financial technology company Nex Group (LSE: NXG). It reported an increase in revenue from continuing operations of 18%, which was a rise of 8% at constant currency. Trading operating profit from continuing operations was 4% higher, which is an increase of 12% when the impact from hedging is excluded. This performance was recorded in a tough environment, but with the company’s focus on expanding its product suite to a wider client base proving successful.
Following the sale of the ICAP Global Broking division for £1.3bn, Nex Group is focused on investing for the future. The annual cost savings identified of approximately £25m by 2019/20 will now be offset by incremental investment for growth. This is expected to help boost the company’s bottom line by as much as 30% in the current year, and by a further 14% next year.
Over the medium term, Nex Group is focused on improving operating margins to at least 40%, which could have a further positive impact on its financial performance. Since the company trades on a price-to-earnings growth (PEG) ratio of just 1.2, now seems to be the perfect time to buy it. Indeed, investors do not yet seem to have fully priced-in its growth potential.
Also offering share price growth potential is electricity generation business Drax Group (LSE: DRX). It has adopted a new strategy which is set to dramatically improve the financial performance of the business. It is seeking to create a more diversified earnings base which could produce higher-quality returns in the long run. In order to achieve this, it has engaged in M&A activity at a time when the biomass transformation project which commenced in 2012 has been completed.
Looking ahead, Drax is forecast to record a rise in its bottom line of 120% in the current year, followed by further growth of 43% next year. Despite such a high potential growth rate, its shares trade on a PEG ratio of only 0.5. This suggests that after a number of years of major declines in its profitability, the market is pricing-in a wide margin of safety.
While understandable, given the four years of double-digit earnings declines from 2013-2016 inclusive, this could provide new investors in Drax with an opportunity to generate index-beating returns in the long run. As such, the company could be a surprisingly strong growth stock.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.