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Are The Restaurant Group plc (-60%) and Interserve plc (-50%) stonking buys, value traps or takeover targets?

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To many investors there’s nothing more appetising than a share that has halved or more in value, this brings out the contrarian in us, believing that going against Mr Market will pay us handsomely as the market comes around to the contrarians way of thinking.

However, the sad fact, as I’ve outlined in other articles on this site is that many investors will end up on the losing end of the trade as things can often become worse before they start to improve.

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And it’s along those lines that I’ve decided to highlight two bombed-out companies; The Restaurant Group (LSE: RTN), which most of us will recognise as the owner and operator of the Frankie & Benny’s chain of eateries, and UK-based support services and construction company Interserve (LSE: IRV).

As can be seen from the chart below, both of these shares have been ravaged by investors dumping them for different reasons – but has this created an opportunity for the brave, or are these shares value traps waiting to snare the unwitting investor before another lurch south? Let’s take a closer look…..

Discount dining?

First up is The Restaurant Group. Traditionally this share commanded a PE ratio in the high teens as the company rolled out its principal trading brands including Frankie & Benny’s, Chiquito and Coast to Coast.

However, all this changed in January when management updated investors on the full year, reporting strong sales and cash flow, but were cautious going into 2016 given the upcoming introduction of the national living wage in April, a possible Brexit and general global uncertainty. With the shares priced for growth, investors headed for the exit giving rise to a 30% fall in the share price.

The most recent update saw the CFO depart with immediate effect (rarely a good sign) and a further deterioration in trading mainly focused at Frankie and Benny’s, causing management to cut earnings estimates for 2016 – when questioned the CEO admitted that they didn’t expect trading to improve in the near term and that it could worsen – this wasn’t what investors wanted to hear and the shares took a further lurch south.

Following the updates, a strategic review has been launched, and while this is in its early stages, it could mean that the company is split, or indeed bought in its entirety by say a private equity group on the hunt for a profitable, cash generative business.

Shaky foundations?

If I told you that there was a share trading on a forecast PE ratio of less than five times earnings and expected to yield over 8%, I’m sure there would be a queue forming at the door, especially if most of the business was trading in line with expectations.

And in the main Interserve is trading in line, apart from a contract under the UK construction division that will now be significantly impacted by further deterioration in an energy from waste contract that will result in further cost overruns and delays causing a £70m exceptional contract provision to be taken in the first half of 2016.

It’s clear that investors are treating this share with caution as things could worsen moving forward, however, for the brave among us – this could represent an attractive entry point.

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Dave Sullivan has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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