The volatility in global stock markets over 2022 so far is enough to shake the conviction of even the most grounded of investors. Here are a few strategies I’ve been using to ride out the storm.

1. Don’t panic-sell

When the chips are down, it’s easy to see why moving into cash is so appealing. It draws a line under the situation and allows me to move on. But does it really?

Beyond holding an ’emergency fund’ to cover, say, a sudden unexpected bill or brief period of unemployment, cash is just about the worst asset I could have right now. Low interest rates and galloping inflation means its value is gradually (or not so gradually!) being eroded. So in addition to crystallising any losses, I’d essentially be jumping out of the frying pan into the fire.

Selling up also implies that I also know when will be the right time to buy stocks again. The sheer volatility we saw on markets last week, where share prices actually rose as the Russian invasion of Ukraine progressed, tells me I don’t.

As a committed Fool, it goes without saying that panic-selling everything I own right now is not something I’m contemplating. 

2. Buy quality

Warren Buffett tells us to “be greedy when others are fearful“. I’d say right now offers me a great opportunity to put this advice into practice.

Now, it doesn’t make sense to buy any old stock on the market and expect it to recover in style. I would, for example, avoid any company lacking financial stability (such as cinema chain Cineworld). I would also steer clear of any business that lacks an identifiable advantage over competitors (such as white goods seller AO World, in my opinion). Instead, I’d be out to snap up proven ‘winners’ in their respective sectors. From the FTSE 100, for example, I remain convinced that Halma is a great growth buy. 

Aside from looking for quality businesses, there are also ways of making the buying process easier from a psychological point of view. One is buying in tranches, otherwise known as pound-cost averaging. Such a strategy helps to avoid trying to time the market exactly (which I know I can’t do, at least consistently). It also ensures at least some of my money starts working for me. 

A third element of my buying strategy is to make sure that anything I snap up is held within a Stocks and Shares ISA. This means any profits I make (and dividends I receive) are free of tax. 

3. Switch off

Assuming I’ve not sold anything in haste and bought things I’ve had on my watchlist, there’s one final solution that’s unsurpassed in helping me deal with stock market volatility. Simply, just switch off. That’s right — close off my portfolio, turn off the laptop, stop watching the news and go and do something more productive.

I have the confidence to do this because evidence shows that equities outperform all other asset classes. This includes cash (naturally), bonds, real estate and gold. The only caveat here is that this requires being invested for the long term.

For someone content to grow his wealth slowly but surely, that suits me. As distressing as current events are, I also know that “this too shall pass“. 

The post 3 Foolish ways I’m dealing with stock market volatility appeared first on The Twelfth Magpie.

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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has recommended Halma. 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.

Some FTSE stocks attract short-sellers like bees to honey. Think battered cinema operator Cineworld or troubled white goods seller AO World. That said, there are other companies where this kind of attention is arguably more surprising. Let’s look at a couple of examples and see whether there’s a buying opportunity for me. 

Is the purple patch over?

It’s interesting to see Kingfisher (LSE: KGF) so high up the table of most hated stocks. Thanks to the explosion in the popularity of DIY over the pandemic and a very healthy housing market, investors might assume that short-sellers would have no interest in the B&Q and Screwfix owner. Then again, recent share price activity suggests otherwise.

Kingfisher certainly hasn’t had the best of starts to 2022. In sharp contrast to index peers like BT and BP, the valuation here has fallen 10% year-to-date. That’s not nearly as bad as the drops seen in tech companies, but it still implies that some in the market think the FTSE 100 member’s purple patch might be over.

Given the above, it’s clear that next month’s full-year results will receive a lot of attention. Back in November, Kingfisher’s share price wobbled after the company revealed like-for-like sales of £3.2bn in Q3 were down 2.4% compared to the same period in 2020.

Is this indicative of more people spending money on other things they couldn’t do previously? Or is it simply a natural fluctuation in earnings that all companies experience? We’ll find out soon enough.

In the meantime, Kingfisher’s stock was trading on a P/E of 11 as markets opened. It also comes with a 3.7% yield. That looks pretty reasonable to me. As things stand however, I’m content to sit on the sidelines and wait to see just how tricky the last quarter has been. 

Shorting target

Another FTSE share that makes the ‘most hated’ Top 10 list is Domino’s Pizza (LSE: DOM). Again, this seems a bit surprising.

Back in December, the company announced it had reached a resolution to a long-running feud with its franchisees. As part of the deal, Domino’s will invest £20m over three years in stores and online apps. Marketing will also be stepped up.

In return, franchisees are expected to open a minimum of 45 stores per annum in the next three years, test and roll out new tech, and get involved in national promotions.

As might be expected, this news sent the shares sharply higher. Unfortunately, a good proportion of these gains have since been lost. Shares have fallen back 16% year-to-date.

But maybe this selling pressure (and shorter interest) does make sense. Like Kingfisher, the trading tailwind from multiple UK lockdowns is now over. The sharp rise in the cost of living could also be relevant. When times are tough, it seems likely that more of us will shun a takeaway in favour of a cheaper, shop-bought alternative. 

As a side note, Domino’s net debt has climbed significantly in recent years. I’d prefer it to be going in the other direction.

But companies with franchise business models often prove to be great wealth-compounders over the long term. Domino remains a highly-cash-generative business and P/E of 19 is also roughly in line with the company’s average P/E over the last five years.

Domino’s has now been added to my watchlist. I wonder if this attention from short-sellers might prove short-lived.

The post 2 surprising FTSE shares being targeted by shorters appeared first on The Twelfth Magpie.

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Paul Summers has no position in any of the shares mentioned. 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.

70% down! 

Online electrical-goods retailer AO World (LSE: AO) was a huge beneficiary of the multiple UK lockdowns. The once-in-a-lifetime pandemic temporarily turbocharged revenue at the Bolton-based business and nimble investors charged in while the going was good.

Since then, however, it’s all been downhill. In fact, the share price has now crashed 70% in the last 12 months. If anything, this highlights the risks involved in buying single company stocks lower down the market spectrum. It also serves as evidence that not every online retailer will thrive. 

As someone who isn’t afraid to adopt a contrarian mindset in the pursuit of long-term gains, I’m pushed to ask whether such a huge fall in the share price is justified. Regrettably, I think it is. In fact, I think the outlook looks increasingly bleak for the shares.

Strategic review

Last month’s Q3 update hardly inspires confidence. While UK revenues were “broadly stable” on a one-year comparative, the company is clearly finding things a lot harder in Germany. According to AO World, trading in the latter has been “significantly impacted” by a toxic mix of increased competition, higher marketing costs and supply chain disruption. Since these trends are expected to continue “for the foreseeable future“, it’s now conducting a strategic review of this division.

If AO World had a global presence, such a move wouldn’t worry me so much. But knowing that Germany represents its only other market — ironic given the company’s name — is deeply worrying.

Shorters assemble 

It’s not just me thinking things could get even tougher for AO World. Right now, the battered growth stock is the fifth most shorted company on the London Stock Exchange. In other words, a significant number of people are betting that the share price still has further to fall. 

For balance, it’s worth remembering that shorters can sometimes be spectacularly wrong in their judgement. If trading recovered then those betting against the company would be forced to close their positions as quickly as possible to avoid huge losses. This activity, when combined with long-only investors piling in, could theoretically lead to this FTSE stock’s value exploding. AO World’s small free float (the percentage of a firm available to buy and sell on the market) might help to move the needle to an even greater extent.

How likely is this to happen? The odds aren’t great based on what I’m seeing.

Better bets than this FTSE stock

Now, AO World can talk all it wants about the rise in online shopping. To stand a chance of making me money, however, I need to see that it’s taking the battle to the substantial competition it already faces. The trouble is, I’m struggling to spot the ‘moat’ that master investor Warren Buffett advises we all hunt for.

If I were looking to invest my finite capital in UK growth stocks today, I’m certain that this FTSE stock wouldn’t get on my buy list. Why take the chance here when I can buy quality companies like these that should compound in value over many years instead?

The post This FTSE stock has crashed 70% and I think things could get worse! appeared first on The Twelfth Magpie.

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Paul Summers has no position in any of the shares mentioned. 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.

Being a sort-of-youthful 40-something, I like to think I’ve got many years left to build a great nest egg for retirement. As a result, my eyes are naturally drawn to investing in the best growth stocks on the UK market. Of course, this strategy also involves knowing what to avoid as much as what to buy. Here are what I believe to be three examples of the former.

AO World

Electricals retailer and lockdown beneficiary AO World (LSE: AO) was one of the best-performing stocks of last year. Had I bought the shares in mid-April 2020, I would have been sitting on a return of approximately 550% by the beginning of 2021.

Since then, however, it’s been a very different story. AO shares have tumbled 60% in value year-to-date (and 24% in 12 months). The issue here is that the white goods seller now has some tough comparatives to live up to. This is evidenced by last week’s six-month trading update. While like-for-like group revenue was 66% higher than two years ago, it’s up only 5% on a one-year basis. To make matters worse, this is a highly competitive space with low margins. 

One might argue that AO World shares now look much more tempting and offer a better margin of safety. However, a price-to-earnings (P/E) ratio of 45 remains staggeringly high considering the company is already being impacted by a shortage of delivery drivers and wider supply chain issues. 

Restaurant Group

Another growth stock I’d steer clear of right now is casual dining firm Restaurant Group (LSE: RTN). That’s despite the company’s shares almost doubling in value in the last 12 months (and having enjoyed a fair few meals at its Wagamama sites in the past). 

Despite restrictions having now been lifted, I’m inclined to think the recovery is fully priced-in. The end of the furlough scheme combined with the recent rise in energy and fuel prices mean that some people could be facing difficult times ahead. That will likely mean a reduction in discretionary spending such as eating out.

Yes, a resumption of travel abroad could see better trading at airports for RTN’s Concessions business. As such, news that the ‘amber list’ has now been scrapped is encouraging. However, wage inflation and a significant amount of debt on the balance sheet still give me cause for concern. If I were a holder, I’d be taking profits and moving on. 

Trainline

A final UK growth stock I’ll be dodging is ticket booking site Trainline (LSE: TRN). 

As one might expect, the FTSE 250 member’s shares fell heavily as lockdowns were enforced in 2020 and few of us commuted to work. Ordinarily, I’d see such a fall as an opportunity to buy, especially as a user of the company’s app myself.

And yet, despite restrictions now being lifted, TRN shares are down almost 9% in the last year. On top of this, they still attract interest from short-sellers. This suggests to me that the market remains sceptical over just how many of us will return to the office as regularly as before. Competition from other ticketing services (like the new state-owned Great British Railways) will be another worry going forward.

Trainline may be outperforming the wider market and doing well internationally, but all told, I just can’t see it increasing my wealth significantly as other UK growth stocks might.

The post 3 growth stocks I’m avoiding like the plague appeared first on The Twelfth Magpie.

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Paul Summers has no position in any of the shares mentioned. 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.

Halfords

Bike and car parts retailer Halfords (LSE: HFD) was a huge beneficiary of the push to exercise during lockdowns. With movement restricted and most shops and all leisure facilities closed, what could be better than peddling the misery away? Sales duly rocketed, followed by its share price.

The company, which also operates auto repair centres, releases its latest set of full-year numbers next month. While the inevitably good numbers should push the shares higher, a cautious outlook could do the opposite. After all, trading may be about to get tougher as the UK prepares to fully unlock.

Halfords faces two problems: those with bikes won’t be in a hurry to replace them and people now want to spend their money on things they’ve been itching to do. On top of this, it still presents as a pretty unexceptional company without last year’s unexpected tailwind. Margins are low. Returns on capital — what it makes on the money it invests in itself — are also very average.

I wouldn’t buy and might even sell some if I needed cash to invest in what I see as a better growth pick.

AO World

Another company that’s done well out of the pandemic has been online domestic appliance seller AO World (LSE: AO). In fact, it was one of the best-performing UK shares last year. The share price rocketed from 57p a pop in April 2020 to 411p a share by 31 December.

Since then, however, we’ve seen sentiment turn. I don’t think this is surprising. CEO John Roberts is confident that AO will “continue to be a double-digit growth business in the year ahead,” but the market seems to think otherwise. On 29 times earnings, the stock also looks pretty expensive for a company with no discernible moat or market-leading position. Will customers remain loyal? I’m sceptical.  

Prior to Covid-19, AO was a loss-making, ‘jam tomorrow’ stock. Without evidence that it can continue to thrive in normal market conditions, I’d be taking some profit here if I hadn’t already started doing so.

Gear4music

Multiple UK lockdowns have also been kind to online musical instrument seller Gear4music (LSE: G4M). Over the last year, the share price has leapt 225%! The question now is whether this momentum can be sustained after the company reports to the market on 22 June.

Like Halfords, Gear4music faces some tough comparisons going forward. While playing music can be a lifelong pursuit, one has to wonder whether people have all the guitars, drums and trumpets they need for now. G4M’s small-cap status also means it’s more susceptible to big share price moves compared to the average FTSE 100 juggernaut. If investors get nervous, the party could be (temporarily) over.

But the long-term growth prospects are surely excellent thanks to the gradual reduction of independent musical instrument retailers on the high street. For this reason, I’d be happy to hold this UK share. If the shares fall back next month, I’d back up the truck and buy too.

The post Would I buy or sell these top-performing UK shares? appeared first on The Twelfth Magpie.

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Paul Summers has no position in any of the shares mentioned. 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.

In spite of today’s half-year results however, I still can’t be tempted. Quite the opposite, in fact.

“A half-year like no other”

Revenue jumped 53.2% to £717m over the six months to the end of September.  Broken down, sales in the UK moved 53.9% higher to £616.4m as people dashed to prepare for working from home. Although a much smaller part of its business, revenue from AO’s operations in Germany also climbed 85.2% to just over £100m.

At first glance, the bottom line looks even more encouraging. Pre-tax profit jumped no less than 417.1% to £18.3m following last year’s £5.9m loss. 

How much?!

Commenting on today’s results, CEO and founder John Roberts reflected that the six months of trading had been “a half-year like no other” and that AO’s market had changed “forever.”  

I completely agree. While I wouldn’t call time on the high street just yet, it does feel like online will become the dominant way to shop in the years ahead. Nevertheless, there remain a few reasons why I can’t be tempted to buy AO.  

The main problem, in my view, is the valuation. Despite being barely profitable, the market thinks AO is now worth a staggering £1.9bn.

To justify this price tag, I need it to be the go-to destination for UK shoppers in this space. Not only is this not the case, it’s also clear AO simply doesn’t have the financial firepower to compete with the likes of, say, US giant Amazon over the long term.

As good as today’s swing to profit was, there’s still net debt of £20.7m on the balance sheet. To put things in perspective, fellow online UK retailer Boohoo has net cash of £345m. Now, that’s a war chest!

With hopes the coronavirus storm may be over by next spring, I’m also inclined to think 2021 won’t be as kind to AO as management suspects. After all, laptops, washing machines or fridges aren’t weekly, monthly, or even annual purchases.

No, if I’m to pay up for a stock, I must feel confident that recent momentum will last. This is why I’d be more likely to buy video game services provider Keywords Studios (LSE: LWS) over AO World.

“Significantly ahead”

Today, the Dublin-based business revealed it now expects full-year adjusted pre-tax profit to come in “significantly ahead of the current market consensus,” at €52m. That’s down to continued strong trading and “good cost control.“ All the more impressive, considering the disruption caused by Covid-19 on production schedules for games. 

With the new Playstation 5 and Xbox consoles likely to be topping Christmas wishlists, I can see the good times continuing. Let’s not forget the exponential growth of eSports either!

Taking today’s gain into account, shares in Keywords are a little over 60% higher in value since the market crash. That’s nothing compared to AO World’s gains. But I know which business I’d be more comfortable owning.

After such a strong run, I’d be inclined to take profits on AO and run. 

The post This UK growth share is up over 700% since the market crash. I’d sell NOW! appeared first on The Twelfth Magpie.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Paul Summers owns shares in boohoo group. The Motley Fool UK owns shares of and has recommended Amazon. The Motley Fool UK has recommended boohoo group and Keywords Studios and recommends the following options: short January 2022 $1940 calls on Amazon and long January 2022 $1920 calls on Amazon. 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.

A strong trading performance

For the four months ending July, year-on-year revenue in the UK was up nearly 60% to £400m. In addition, German revenues rose 91.5% to £67m. This was particularly encouraging as the firm has often struggled within Europe.

The other promising sign for the share was that revenues surged in both the months during lockdown and following the easing of lockdown restrictions. This proves that the revenue increase was not just a short-term boom when other shops were closed. The company said that it indicated a “structural shift in demand” that AO World should continue to profit from.

Problems with the growth share

Despite evidence of significant growth over the last few months, AO World still does have a few problems. The main problem for shares over the past few years has been its failure to make a profit. For example, in the financial year ending March 2020, the group made an operating loss of £3.8m. Although this was an improvement on the £13m loss made the year before, a consistent failure to make profits is always a worrying sign. Shareholders will therefore hope the company can generate a profit this year.

There is also the worry that this sales boom has been a one-off. Consequently, with people starting to return to work, and with significant competition from other retailers, revenues may start to fall near the end of the year. A potential lack of growth is therefore a significant problem for any growth share.

These problems may have influenced some recent insider selling by both the CFO and one of the directors. Although insiders can sell for a number of reasons, it is nonetheless a bearish signal. Nevertheless, I’d pay more attention to the CEO’s decision to buy £1.5m worth of shares a few weeks ago, a clear vote of confidence for further growth.

Would I buy AO World shares?

With the evident popularity of online shopping, AO World shares look set to profit in the long term. As a result, I believe that there is upside potential, despite the shares already being valued highly. Even so, I’m personally not buying any of the shares right now. Why? For a company that has been unable to make a profit these past few years, its share price does look high. I’d therefore want to see some evidence of sustained profits before buying this growth share.

The post This FTSE 250 growth share has risen over 300%. Should investors keep on buying? appeared first on The Twelfth Magpie.

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Stuart Blair has no position in any of the shares mentioned. 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.

Personally, I think things might get worse before they get better. With this in mind, here are three stocks from lower down the market spectrum that I think are definitely worth paying attention to next month.  

Hot stock

First up is infection prevention product supplier Tristel (LSE: TSTL). For fairly obvious reasons, this is a company that has received a lot of attention from investors recently. And despite slipping back in recent weeks, its stock is still up 46% since March’s nadir.

Tristel is a company I’ve coveted for a while. The only problem is that its shares have long felt very expensive. Right now, for example, they change hands for 38 times earnings. That’s punchy when the future looks so uncertain, even for a company in a ‘hot’ space. 

But if there is a significant second wave, the shares could be one of the few winners. If, however, there’s a mass market crash for more economic reasons, some of the recent gains could be lost. 

I’ll definitely be checking out the firm’s latest trading update on 22 July.

Lockdown winner

A second small-cap reporting in July is one I’ve hitherto avoided like the plague: online electrical retailer AO World (LSE: AO). More fool me. The shares are up almost 200% since March’s market crash.

As you might expect, AO has been a huge beneficiary of the lockdown with more people needing tech to work and shop from home. Earlier this month, it spoke of having grown market share and seeing “increased demand and sales across all categories”. The question now is whether the shares can extend their gains or everything is fully priced-in? I’m inclined to think the latter.

As much as it’s made money for opportunistic investors in recent times, I just can’t get excited about a business operating in such a competitive sector. When demand is massive, even loss-making firms (such as this one) can do well. What happens, however, when supply chains at larger rivals get back to normal?

Still, good luck to those already holding. For those who aren’t and fancy a (very-un-Foolish) dabble, I suggest only doing so with money you won’t miss. 

AO is down to report to the market on 14 July.

Calm before the storm

My third pick of shares worth watching in July is an old favourite: insolvency specialist Begbies Traynor (LSE: BEG). If any stock is a compelling counter-cyclical candidate at the current time, this must surely be it. 

Last month, Begbies reported that it continues to trade well “with strong growth in revenue and profit compared to the prior year“. With many businesses still shut, I suspect this situation won’t have changed by the time the company reports full-year figures on 21 July.

But forget the last few months — I think the firm might be flooded with business in the rest of 2020. And even if it takes some time for this to be reflected in the share price (particularly if there’s a second market crash), there will be dividends to collect in the meantime. 

Begbies trades at almost 16 times earnings and yields a forecast 3.2% for FY21.

The post Fear market crash 2.0? Watch out for these small-cap stocks in July appeared first on The Twelfth Magpie.

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• With a 7% yield, is this dividend share a no-brainer?
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• With a yield of 6.8% and a P/E ratio of 12.1, is this a dirt cheap FTSE 250 stock to consider?
• Will SpaceX, Nvidia, or Alphabet be the first $10trn stock?

Paul Summers has no position in any of the shares mentioned. 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.

Retailers in the area come and go, but mostly go. And the big problem is bigger-ticket items like that have become commoditised over the last 30 or so years. Have you ever looked back and realised you just paid around the same price for your new appliance you paid three decades ago for one?

Built to fail?

It used to be that big appliances were built to last, and there was a whole industry dedicated to service and repair so the equipment could keep running for years. The ticket price used to justify the maintenance activity because repairing was often more economical than replacing the item.

Those days are gone. Now, a repair will often cost more than the value of a new appliance. So the servicing industry has declined and most faulty appliances end up at the recycling centre.

But people have to dispose of their appliances much sooner than they used to. Today, it seems many appliances are built to fail rather than being built to last. They’ve been changed into commodity items for using up and replacing while being sold for a price point much lower than they used to.

That’s bad news for those who aim to retail them. Sure, they get more repeat business, but the profit margins are so low  its hardly worth going to all the effort to sell appliances in the first place. I think that’s true for traditional bricks-and-mortar appliance merchants and for online operations such as AO World (LSE: AO), which delivered its full-year results report today.

Dire figures

The figures are grim. Although revenue grew by just over 13% during the trading year to 31 March compared to the previous year, the diluted loss per share rose almost 30% to just under 4p per share.

A glance at the cash flow statement reveals just how strained the company’s activities are. Cash used in operations rose to £34.5m, up from £15.4m the year before, much of the money going into inventories and receivables. But even if you strip out movements in working capital, AO lost £3.6m from operations, up from a loss of £2.9m the year before. Whichever way you look at it, it’s losing money instead of making it.

But this problem isn’t new. In five years as a public limited company, the firm has consistently lost money despite increasing sales and revenue. So I’d avoid the company’s shares.

Instead, my plan for making a million on the stock market would involve looking for well-diversified gains from investing in a basket of solid, profitable, dividend-growing companies. Or by putting money into a share-backed fund such as a low-cost index tracker following the fortunes of an index like the FTSE 100 and others.

The post Forget AO World! Here’s my plan for making a million on the stock market instead appeared first on The Twelfth Magpie.

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Kevin Godbold has no position in any share mentioned. 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.

One technique favoured by many successful investors is to look for companies with high profit margins and a clear competitive advantage. Known as quality stocks, these companies can often grow sustainably for many years.

Motoring ahead

In my view, FTSE 100 car marketing group Auto Trader Group (LSE: AUTO) is a good example of a quality business. More than 80% of the UK’s automotive retailers advertise on autotrader.co.uk, which receives about 55m visits per month.

Over the 12 months to 30 September, the group generated an operating profit of £232m on sales of £341.9m. That gives an operating profit margin of 67.8%, which is exceptionally high.

This is special

High profit margins are great, but they don’t tell the whole story of a firm’s profitability. To understand this, we also need to consider how much capital investment is needed to generate these profits.

Auto Trader doesn’t need expensive factories, warehouses or transport infrastructure. It just needs some offices and a fairly small number of staff. Capital investment in the business is low.

The combination of high profit margins and low capital intensity results in a very high return on capital employed (ROCE).

My sums show that Auto Trader generated a ROCE of 65% over the 12 months to 30 September. That means for each £1,000 of capital employed in the business, it generated an operating profit of £650. That’s extremely high.

Keep buying?

Auto Trader’s high returns mean that it generates a lot of surplus cash. Some of this is returned to shareholders as dividends, but an increasing amount is being used to buy back and cancel the firm’s own shares.

The advantage of this approach is that it boosts future earnings growth and reduces the number of shares on which dividends must be paid. This supports more rapid dividend growth.

Auto Trader shares may not seem cheap, with a forecast P/E of 20 for 2019/20 and a dividend yield of 1.7%. However, earnings per share have risen by almost 50% since the group floated in 2015, and the dividend is growing at more than 10% per year.

I think further gains are likely and rate the shares as a long-term buy.

I’m avoiding this growth stock

In contrast to Auto Trader, online electrical retailer AO World (LSE: AO) faces brutal competition from larger rivals.

Trading figures released today suggest growth may be slowing. Group sales rose by 8.2% during the final quarter of 2018. That’s less than half the 16.6% sales growth reported for the same period in 2017.

That’s a potential concern, as I think one of AO’s most serious problems is that it’s not really big enough. The group’s sales are less than 10% of those made by market leader Dixons Carphone.

What happens next?

In fairness, AO’s UK business is profitable. However, these slim profits are being spent on a loss-making effort to expand into Europe. In my view, the company should scrap its European ambitions and focus all its efforts on the UK.

Doing this could give shareholders a chance to earn reasonable returns. However, another year of losses is forecast for 2018/19. I think this stock is seriously overvalued and best avoided.

The post Why I think this FTSE 100 dividend stock could help to double your State Pension appeared first on The Twelfth Magpie.

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Roland Head owns shares of Dixons Carphone. The Motley Fool UK has recommended Auto Trader. 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.