Why I’d swap this overpriced share for this bargain growth stock

One Fool would sidestep one popular share for an under-the-radar small-cap.

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AO World (LSE: AO) wants to become the leading European online retailer of electrical products and I reckon it’s got a decent chance of getting there eventually, but just because the company might eventually fulfil its mission statement doesn’t mean it’ll make a great investment. 

 I believe its focus on customer service, including quick delivery times, installation offerings and price-matching, is attractive to customers but could be detrimental to shareholders.

AO World doesn’t manufacture its own products but is a distributor that takes a cut of each sale completed through its platform. Unfortunately, it operates in a sector where competition is intense and margins are wafer thin and I don’t believe it can bear the burden of extra costs.

It earned a miniscule £15.6m operating profit on UK sales of £629.7m last year, while the European business reported a £27.6m operating loss on sales totalling £71.5m. 

The company was lossmaking at an operational level despite £700m sales. That concerns me given the heady £512m valuation. Perhaps a stronger growth rating in line with other internet retailers like Boohoo.Com would justify such a valuation, but the company only grew sales by 17% last year. I’m sure it offers great service to customers, but I can’t imagine investors receiving the same satisfaction unless growth or margins transform soon. 

Perhaps rampant growth could justify this valuation, but we’re not getting that. With such disappointing expansion rates and tough trading conditions in the UK,  I can’t imagine shareholders being looked after as well as customers for a long time yet. 

A shareholder-friendly property expert

Inland Homes’ (LSE: INL) business model seems more shareholder-friendly to me. It made an £18.1m profit before tax last year on revenues of only £90m.

The firm’s expertise lies in its ability to identify and acquire promising brownfield land within the London commuter belt. It aims to enhance the land value by obtaining planning permission before building open market and affordable homes or selling surplus consented land to other developers to generate cash.

Of course, the firm has benefitted from rising property prices in recent years and would suffer if the market were to turn, but property bulls point to structural developments that could continue to prop up prices, not least an ongoing population boom in London that could drive demand for property in commuter towns too.

The company has been on a roll recently, securing planning permission for nearly 1,856 plots last year. Right now, a record 427 units are under construction.

If the company can continue to produce value from its land bank, which currently has the potential for 2,200 units, it could be a steal. Net asset value came in at £131m, slightly more than its current market cap. Plenty of the company’s assets, including brown-field sites with massive upside potential, are recorded on the balance sheet at cost so this figure is likely conservative. The companies EPRA NAV, which includes an estimate of the unrealised value within projects, was £194m.

Investors should note the increasing debt load at the company. For those bullish on the company’s prospects, the shares currently offer a 2.9% yield.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Zach Coffell has no position in any shares mentioned. The Motley Fool UK has recommended Inland Homes. 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.

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