Why I’d buy this FTSE 100 dividend stock right now after falling 30%

Man making notes on graphs and charts
Man making notes on graphs and charts

Every so often, I stumble across an investment opportunity that is too good to miss. I believe FTSE 100 income champion Melrose (LSE: MRO) falls into this bucket.

Over the past 12 months, shares in the engineering conglomerate have slumped by 30%, underperforming the FTSE 100 by 22.5% excluding dividends. The sell-off has only accelerated over the past few months. Indeed, since mid-May, the stock has been off 40%.

But why are investors rushing for the exits, especially when Melrose has such an impressive record of producing returns for them?

Buy, improve, sell

Melrose is an expert at buying, improving and then selling underperforming engineering companies, like GKN, which the group finally acquired after a protracted takeover battle earlier in the year for £8bn.

Since its first acquisition in 2005, Melrose has delivered £4.8bn of value to investors using this strategy, and investors who bought in at the IPO have seen their investment grow at an average rate of 25% per annum over the past 13 years.

These are fantastic results, and I see no reason why Melrose’s experienced team cannot continue to churn out similar returns for investors going forward.

That being said, headwinds are growing for the group’s engineering businesses. Brexit and Trump’s trade war are both significant threats to Melrose’s enterprises. It would appear that these concerns are behind the recent sell-off.

However, this is not the first time management has had to contend with unfavorable operating conditions, and with this being the case, I believe now could be the time for savvy value investors to build a position in the stock.

City analysts seem to agree. Over the past few months, 2018 earnings per share (EPS) estimates for 2018 have jumped 20%. As EPS estimates have gone up, and the share price has gone down, Melrose’s valuation has only gotten cheaper. Right now, the stock is changing hands for just 12.8 times forward earnings.

In my mind, this valuation severely undervalues Melrose’s prospects, and that’s why I rate the stock a ‘buy’ today.

Troubled times

Another growth stock that I believe is currently a ‘buy’ is RPS(LSE: RPS).

Shares in this consultancy business have lost around a third of their value over the past six months. These declines have taken the stock down to a valuation of just 11.8 times forward earnings. There is also a 4.8% dividend yield or offer.

It seems that the market has soured on the RPS business because earnings are falling. The City was expecting the group to announce a 230% rebound in EPS for 2018, but today management has come out to confirm that fee income “will be marginally below market expectations,” while profit before tax and amortisation for the year will be “slightly below” 2017’s figure.

Unfortunately, management also expects more of the same in 2019.

Time to buy?

The firm’s downbeat outlook is disappointing, but I think it presents an exciting opportunity for patient investors.

RPS is struggling to grow because the group is investing heavily in its offering around the world. Over time these efforts should pay off, although they will hit earnings in the near term. However, I reckon that long-term holders won’t be disappointed when the growth comes through.

As there’s also a 4.8% dividend yield on offer, investors are being paid to wait for a recovery.

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Rupert Hargreaves does not own any share mentioned. The Motley Fool UK owns shares of Melrose. 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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