Why this dividend growth stock could be a better buy than AstraZeneca plc

The Motley Fool

Big-name dividend stocks build their reputations as reliable payers over decades. But they don't always offer investors the best opportunity to earn attractive returns.

Today I'll discuss whether a little-known tech stock could be a better choice than pharma giant AstraZeneca (LSE: AZN) for investors wanting both income and growth.

Against the odds

Defying expectations, AIM-listed XLMedia (LSE: XLM) has doubled in value over the last two years. This internet marketing group makes most of its money by recruiting new customers for online gaming operators.

Investors have always been a bit suspicious about the quality of this business. There's always a risk that regulatory changes -- or Google changes -- could hit profits. However, management is aware of this risk and the company is taking steps to diversify.

On Monday, XLMedia announced the acquisition of a US price comparison website www.moneyunder30.com, which should complement a similar business acquired recently in Canada. Personal finance is a large and growing market, so could provide an attractive opportunity.

It's also worth noting that even this company's critics admit that its financial performance has been very impressive since it floated in 2014. Net profit has risen from $9.8m in 2014 to $23.9m last year. This progress has been backed by strong cash generation, leaving net cash of $35.2m at the end of last year.

Shareholders have been rewarded with rising dividends, which give the stock a trailing yield of 4.4%. But despite the shares' strong performance, the current share price of 133p gives an undemanding forecast P/E of 12.7. In my view, it's not too late to consider investing in this stock.

What about AstraZeneca?

Star fund manager Neil Woodford has recently restated his commitment to AstraZeneca. According to his blog, Mr Woodford's view is that "very little of what I believe the company will achieve is reflected in today's share price".

One particular point made by Mr Woodford is that the firm's current valuation doesn't give much credit to chief executive Pascal Soriot's goal to double sales by 2023. I agree. If Mr Soriot is able to deliver on this ambitious target, then if profit margins remain stable, the shares could be worth significantly more.

What concerns me is that private investors are not in a position to judge the commercial potential of AstraZeneca's pipeline. For us, it's pretty much a black box out of which successful new products may one day emerge.

The evidence so far seems to be that progress is slow and costly. The group's net debt has risen from almost nothing at the end of 2013, to $10,657m at the end of 2016. Although after-tax profits have recovered from a low of $1,233m in 2014 to $3,499m in 2016, this still leaves the stock on a trailing P/E of 22.

A further improvement in profit to $4,594m is expected for 2017. This puts AstraZeneca on a forecast P/E of 15, with a prospective dividend yield of 4.8%. For investors with a patient outlook and confidence in the group's plans, this could be a decent entry point.

My concern is that for the stock to look cheap, I have to take a significant leap of faith in the company's ability to transform its portfolio. I'm not really comfortable with this, so I'm staying away for now.

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Roland Head has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Alphabet (A shares) and Alphabet (C shares). The Motley Fool UK has recommended AstraZeneca. 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.