Sometimes it's worth trying to catch a falling knife – this one offers growth and income

Telegraph

28-03-2025

Questor is The Telegraph's stockpicking column, helping you decode the markets and offering insights on where to invest.
Some investment adages are, quite simply, utter nonsense. For example, 'do not try to catch a falling knife' suggests investors should not purchase any stock that has fallen heavily. However, given that the underlying aim of stock market investing is to buy at a low price and subsequently sell at a much higher price, the advice seems to be woefully misguided.
Moreover, by adhering to the adage, investors could end up only buying shares that have risen sharply. This means they are likely to pay an overly inflated price that provides little scope for capital growth, since the stock's upbeat future prospects may have already been factored in by their peers.
Questor, of course, typically ignores the past performance of stocks when determining their investment appeal. As a result, the 27pc slump in Morgan Advanced Materials' share price over the past year does not preclude it from obtaining a 'buy' rating.
The FTSE 250-listed company, which manufactures carbon and ceramic materials used in a variety of industries including healthcare and aerospace, has fallen out of favour with investors following its recently released annual results.
They showed the company is experiencing a challenging operating environment, with weak demand in many of its markets. This contributed to a disappointing financial performance – revenue fell by 1.3pc.
Although tough trading conditions may persist in the near term and could even worsen amid a global trade war, the long-term prospects for the business are upbeat. Interest rate cuts already enacted in several of its key markets, notably the US where 41pc of its sales are generated, have not yet had their full impact on economic growth due to the existence of time lags. With further monetary policy easing likely to be ahead, the company's operating environment should improve over the coming years.
Despite reporting a declining top line, Morgan Advanced Materials' efficiency programme contributed to a 6.7pc increase in operating profits last year. Indeed, its operating profit margin rose by 90 basis points to 11.7pc. This figure is set to further rise by 80 basis points in the current year as additional cost reductions are realised.
Morgan's profitability was also enhanced by price increases, which suggests it has a strong competitive position, a fact further evidenced by a return on equity figure of 15pc. This was achieved despite the company having a moderate net gearing ratio of 70pc. Net interest cover, meanwhile, was in excess of five during the year. As a result, it appears to have a solid financial position through which to overcome an uncertain economic period.
The stock's recent decline means that it trades on a price-to-earnings ratio of 8.3. This indicates that it offers a wide margin of safety, with investors appearing to have already priced in the potential for further industry-related challenges over the short run. When combined with a forecast double-digit annualised increase in earnings over the next two years, it suggests the company is significantly undervalued.
As well as offering capital growth potential, Morgan Advanced Materials has income investing appeal. Its shares yield 5.8pc, which is around 230 basis points higher than that of the wider mid-cap index, following their recent slump. With dividends covered a healthy 2.1 times by earnings, they also appear to be highly affordable.
Certainly, dividend growth of 1.7pc last year was disappointing. It is also unlikely to keep pace with the company's bottom line increases over the coming years, since the firm is aiming to expand dividend cover to 2.5. However, given that its earnings are forecast to increase at a brisk pace over the next two years, the rate of growth in shareholder payouts is still likely to surpass inflation.
As a result, Morgan Advanced Materials becomes the latest addition to our income portfolio. We will use cash generated from recent sales to fund its notional purchase.
The stock has proved to be a disappointment since Questor tipped it as a 'buy' in March 2018. It has fallen by 34pc since then, underperforming the FTSE 250 by 36 percentage points. Given its uncertain near-term outlook, it would be unsurprising if share price volatility is elevated in the coming months.
However, with a sound competitive position, a solid balance sheet and a low valuation, the company has long-term capital growth potential. Its improving operating outlook should also act as a positive catalyst on its financial performance, while a relatively high yield and dividend growth potential mean it has long-term income investing appeal.