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Is now the time to add this FTSE 250 share to my portfolio?

Bearded man writing on notepad in front of computer
Bearded man writing on notepad in front of computer

The FTSE 250 is a great place to start when looking for an investment opportunity. These companies have lower market capitalisations than the much bigger firms in the FTSE 100, with an average value of £1.2bn. This level is considerably lower than the near £20bn average of the FTSE 100. Yet the fact that these companies are smaller can often make it easier to find excellent opportunities.

The FTSE 250 can be neglected by institutional investors. That means 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 such potential opportunity is Softcat (LSE: SCT), a UK-based technology infrastructure and service provider. The stock has struggled in 2022, down 34.2% and down over 46% from its peak in 2021. This fall is a prime example of how a company can go from achieving stellar share price growth year on year to falling rapidly. And it;s done this even when the fundamentals have remained mostly the same.

Underlying fundamentals

When looking at the underlying fundamentals of Softcat, I’m pleasantly surprised. It has very high levels of cash generation, sensible profit margins, and extremely high efficiency at generating income from invested capital. In addition, the company has low levels of debt and impressive earnings forecasts.

Turnover is forecast to increase by 20% next year, almost double the average growth over the last three years. Furthermore, bottom-line earnings per share (EPS) are expected to increase by 10.5%, a very encouraging sign. Both turnover and profit have increased consistently over the last seven years following the company listing on the market in 2015.

Dividend-earning potential

Another appealing element of Softcat is that the company is currently paying a dividend of 1.8%, which is forecast to reach 3.6% next year. This dividend has been paid consistently for the last six years and has grown for the previous five. This is quite unusual for a growth company. Any additional income is often used to fund expansion rather than pay dividends.

Future headwinds

Despite these appealing underlying fundamentals, it’s important to note that the company currently has a price-to-earnings (P/E) ratio of a high 24.6. This is forecast to fall to just over 22 next year. However, even after this decline, it will be around double the index forecast average of 10.2.

Furthermore, this elevated level is after the considerable share price falls that have taken place over the last year. This high P/E level could indicate that the company is overvalued, so subsequent falls could be justified. These may simply bring the share price closer to a more realistic level.

Nonetheless, I believe Softcat presents a promising opportunity to add a high-quality growth company at a significant discount. I’d like to add it to my portfolio once I get the necessary funds.

The post Is now the time to add this FTSE 250 share to my portfolio? appeared first on The Motley Fool UK.

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Gabriel McKeown has no position in any of the shares mentioned. The Motley Fool UK has recommended Softcat. 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