This electric small-cap is thrashing the IQE share price

IQE (LSE: IQE) was one of hottest AIM growth stocks through much of 2017. However, it’s been a different story over the past 12 months with its shares having fallen 37%. XP Power (LSE: XPP), which is listed in the FTSE SmallCap index, has outperformed IQE by a wide margin, its shares having gained 3% over the same period.

Now, a 3% gain is hardly shooting the lights out, but it’s this fairly subdued performance and a trading update today that lead me to rate XP Power a ‘buy’ at its current share price of 3,000p (market cap £577m). Meanwhile, IQE, whose shares are trading at around 80p (market cap £612m), presents me with something of a conundrum, but I’ll come to that shortly.

Powerful performer

XP Power designs and manufactures power controllers for major blue-chip original equipment manufacturers. Power controllers are essential hardware components that convert power from the electricity grid into the right form for electrical equipment to function.

The company has a strong record of increasing revenue, earnings and dividends. In today’s trading update, it said revenue increased 24% (at constant currency) for the nine months ended 30 September. This was helped by two acquisitions during the period, but stripping these out, like-for-like revenue growth was still strong at 11%.

Based on full-year City forecasts of 19% earnings growth, XP Power trades on a price-to-earnings (P/E) ratio of 17 and a price-to-earnings growth (PEG) ratio of 0.9. The latter is on the good value side of the PEG fair value marker of one. A prospective dividend yield of 2.8% is also attractive for this type of growth company.

It’s not only the current valuation that leads me to rate the stock a ‘buy’, but also today’s longer-term outlook statement: “The Group believes it is continuing to take market share as its portfolio of industry-leading power technology products is increasingly designed-in to new equipment by our target customers. These design wins will translate into orders as our customers’ projects move to production phase over the coming years.”

Unduly risky?

City analysts aren’t expecting IQE’s earnings to advance this year, with the company having indicated at the half-year stage that it’s investing for future growth. However, looking ahead to 2019, forecasts of 47% earnings growth give a P/E of 15.5 and a super-cheap PEG of 0.33. In contrast to XP Power, IQE currently pays no dividend, but the earnings valuation appears attractive on the face of it.

The company supplies advanced wafer products and wafer services to the semiconductor industry and claims to have a significant technology leadership over its competitors. The potential for IQE to become the default supplier in the upcoming explosion of the Internet of Things certainly turned my head, albeit I saw an investment in the company as being in the higher-risk category.

However, I think I made an error in my enthusiasm, because I put aside one of my faithful criteria for guarding against unduly risky investments. IQE is among the most heavily shorted stocks on the London market. Now, hedge funds may short stocks for a variety of reasons, but when, as in IQE’s case, those reasons include doubts about things as fundamental as a company’s technology leadership and its accounting practices, it’s a steer-clear stock for me. As such, purely on this basis, I’ve added IQE to my ‘avoid’ list.

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G A Chester has no position in any of the shares mentioned. The Motley Fool UK has recommended XP Power. 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.

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