2 inflation-busting dividend growth stocks I might buy for my ISA

The Motley Fool

Selling growth stocks too soon can be a costly mistake. Successful companies can often look expensive for long periods as they grow. It's in these times that investors can sometimes enjoy the biggest gains.

Today I'm looking at two highly-rated engineering stocks whose recent performance suggests they could continue to climb. Stocks like these can be ideal choices for your ISA as future capital gains and dividends will be tax-free.

Steaming gains

Shares of FTSE 250 group Spirax-Sarco Engineering (LSE: SPX) rose by 3% this morning after the company said that its adjusted pre-tax profit rose by 29% to £229.1m in 2017.

This 130-year old firm produces industrial steam systems and a variety of other specialist products. Sales rose by 32% to £998.7m last year, thanks to a mix of organic growth, acquisitions and favourable exchange rate movements. Shareholders will receive a total dividend of 87.5p, an inflation-beating 15% increase on 2016.

Why I'd buy

Today's figures show that the firm's underlying trading margin rose by 0.9% to 24.7% last year, while its adjusted return on capital employed rose from 47.9% to 52.9%. These high figures drive the group's strong cash generation. They mean that it's able to expand continuously without needing much debt.

Such high profit margins also suggest to me that the firm's products have a competitive advantage, perhaps because their specialist nature means that competition is limited.

The shares do look expensive, with a 2018 forecast P/E of 25 and a dividend yield of just 1.6%. But analysts expect earnings to rise by 11% this year. I believe it would be premature to call the top on this stock just yet.

I sold too soon

I invested in reinforced polymer engineering group Fenner (LSE: FENR) just before the mining slump hit rock bottom. This company produces heavy duty conveyor belts for mines and a variety of polymer products for the oil, gas and medical sectors.

My shares performed well during the first part of the mining sector recovery, but I sold for a modest profit much too soon. Had I held on, I'd now be sitting on a 120% profit at current prices.

My mistake was selling when the shares started to look expensive. I focused too much on past performance, not on the potential success of the group's turnaround strategy. This has been impressive.

Strong momentum

The group's operating margin reached 8.1% last year, but it's been above 10% in the past. I suspect this year will see another increase.

January's trading update revealed that results for the year to 31 August are expected to be ahead of forecasts. Analysts now expect the firm to report adjusted earnings of 22.2p per share this year, a 25% increase from last year. Fenner's dividend is expected to rise by 20% to 5p.

The group's earnings should rise by a further 20% in 2018/19, giving the stock a price/earnings growth ratio of 1.2. That still looks affordable to me, despite the P/E ratio of 21.

Fenner would be my pick of the two shares I've looked at today. I'd continue to hold and would consider buying more.

Capital Gains

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Roland Head has no position in any of the 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.