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I’d add this FTSE 250 share to my portfolio for 2023

Young happy people looking at sparklers in their hands on New Year's Eve
Young happy people looking at sparklers in their hands on New Year's Eve

The FTSE 250 is a great place to start when looking for an investment opportunity. The companies in it have lower market capitalisations than the much bigger firms in the FTSE 100 and are often neglected by investors. The average FTSE 250 share has a value of £1.2bn. This is considerably lower than the nearly £20bn average of the FTSE 100. As a result, these smaller companies can often produce excellent opportunities that many investors haven’t spotted.

Large institutional investors are often forced to invest in higher-value companies due to liquidity restrictions. This is a key reason why the FTSE 250 is somewhat neglected in comparison to the main market. As a result, high-quality companies can, at times, trade at levels that don’t reflect their underlying fundamentals. This is especially apparent within the growth sector. Rapidly growing companies may drop considerably almost overnight when they fall out of favour with these more prominent investors.

One potential opportunity is Greggs (LSE: GRG), the UK’s largest baked goods chain. After a remarkable recovery in 2021, rising 86.4%, the share has struggled in 2022, down almost 40%. This massive swing in share price performance is a prime example of the sudden sentiment change that can occur in the smaller UK markets. The company has gone from stellar price growth yearly to falling fast, even when the fundamentals are broadly in line with previous years.

Strong fundamentals

When looking at Greggs’ figures, I’m very happy. It has impressive levels of cash generation, significant profit margins, and is efficient at generating income from invested capital. It has low debt levels too, which are only slightly up from its three-year average.

Turnover is forecast to rise 18% next year, almost triple the average growth of the last three years. However, bottom-line earnings per share (EPS) are expected to rise by just 3.1%, well below the three-year average of 17.6%. Yet on further inspection, this reduced growth rate is due to the rapid EPS growth following the pandemic. Turnover and EPS are above pre-pandemic levels and have been growing consistently year on year, other than in 2020.

Dividend potential

Another encouraging factor for Greggs is that it’s currently paying a dividend of 2.8%, which is forecast to reach 2.9% next year. This is quite unusual for a growth company, as additional income is often used to fund expansion rather than pay dividends. Nonetheless, this is a significant benefit and consistent income would help offset periods of share price decline in the long term.

Future headwinds

Despite these appealing numbers, it’s important to note that the company currently has a price-to-earnings (P/E) ratio of 17.8. Even though this is forecast to fall to 17.3 next year, it’s still quite high given the share price decline of the last year. This high P/E could mean the company is overvalued, as it’s significantly above the index forecast average of 10.2.

Yet I still think Greggs is a unique opportunity to buy a high-quality growth company at a significant discount. Therefore I’ve added the stock to my portfolio.

The post I’d add this FTSE 250 share to my portfolio for 2023 appeared first on The Motley Fool UK.

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Gabriel McKeown has positions in Greggs. 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.

Motley Fool UK 2022