Why these 2 stocks have strong earnings potential

Although many major companies are aggressively priced significant value can still be found in some of medium caps listed on the ASX. Here are two of my core favourites.

IMF (ASX: IMF) provides litigation funding for commercial cases where the damages claimed exceed $5 million – in practice amounts claimed are usually well in excess of this. No ambulance chaser, IMF is extremely selective and undertakes extensive due diligence before agreeing to fund any claim.

IMF’s record speaks for itself – over 12 years of operation only 3% of 149 cases undertaken have been lost (65% settled, 23% withdrawn and 9% won in court).

Historically IMF’s income (not profit) comes in around 17% of claim value. IMF has identified possible claim values of $765 million in 2014 and $670 million in 2015 (these are all cases that are underway). If it goes to plan, adjusted earnings per share would be 25c in 2014 and 24c in 2015, placing IMF on a forward price earnings of 7-8 and a projected yield of 7%+.

However this understates the case for an investment in IMF. No account is taken of the potential Wivenhoe Dam action or further implications developing from the Netherlands-based proceedings against Royal Bank of Scotland N.V and McGraw Hill International (UK) Ltd (owner of ratings agency Standard & Poors). If successful these two cases alone could result in significant settlements.

In addition IMF has $70 million in cash and is building scale in the US with offices in New York and Los Angeles. IMF’s US reputation was recently enhanced when directors Hugh McLernon and John Walker were included in The American Lawyer’s ‘Top 50 Innovators in Big Law in the Last 50 Years’. Following recent legislative changes, a London office is being contemplated.

As earnings from litigation tend to be lumpy and the legal process slow, IMF may not be everyone’s cup of tea. Nonetheless the investment case is compelling in my view.

Servcorp (ASX: SRV) develops and operates serviced and virtual offices on a worldwide basis. Leading edge technology ensures Servcorp has a significant competitive advantage over competitors, especially when catering for international companies.

Since the GFC, Servcorp has doubled capacity and entered the US market in aggressive fashion with 22 US floors now open for business. As Motley Fool contributor Claude Walker points out in his article, Servcorp can partly be seen as a real estate investment due to the majority of recently opened floors being secured on highly attractive terms.

The large capital investment in new capacity and associated costs has affected financial returns over the past few years (it typically takes 1-2 years for new floors to reach maturity) however patient shareholders are now set to receive substantial rewards over the medium term.

It isn’t difficult to see strong earnings per share growth for Servcorp — powered by maturing floors, improving economies, a lower Aussie dollar and further organic expansion.

Foolish takeaway

IMF and Servcorp have proven and astute management, healthy balance sheets, negligible debt and positive reputations in their respective industries. Both cater to global growth markets and are building sufficient scale to take advantage of these. On 2013 earnings alone neither is cheap however both have now built the platforms for sustained profit growth and are undervalued on a medium-term perspective.

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Motley Fool contributor Peter Andersen owns shares in IMF and Servcorp

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