One FTSE 250 stock I’d buy to beat the State Pension in October (and one I’d avoid)

Roland Head suggests a surprise FTSE 250 (INDEXFTSE:MCX) pick for buy-and-hold investors.

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If you’d like to build a stock portfolio to provide an income that’s greater than the State Pension, then one option is to buy stocks now that are at the start of a long period of recovery and growth.

Doing this could mean that you’ll enjoy years of rising earnings and dividends, giving you a market-beating return on your original investment.

Today I want to look at two stocks that could fit the bill.

Slow progress?

Outsourcing and construction firm Interserve (LSE: IRV) announced the sale of its scaffolding business this morning, for up to £4.6m. The news follows the group’s recent half-year results. These showed that headline operating profit fell by 29% to £40.1m during the six months to 30 June, compared with the same period last year.

Management tried to put a positive spin on these figures by pointing out that they were better than the second half of 2017. That’s true. But this doesn’t disguise the fact that Interserve ended the period with increased net debt of £614.3m. This is more than six times trailing earnings before interest, tax, depreciation and amortisation (EBITDA).

The company’s lenders won’t allow it to pay a dividend until the group’s net debt-to-EBITDA ratio falls below 2.5x. In my view this is unlikely to happen until the company holds a rights issue to raise fresh cash from shareholders.

What comes next?

Analysts’ forecasts suggest the City holds a similar view. Although adjusted earnings are expected to triple to 19.3p per share next year, the current share price of 56p puts the stock on a 2019 price/earnings ratio of just 3.

In my opinion this indicates that the market doesn’t expect Interserve to deliver a sustainable recovery without raising fresh cash and diluting shareholders. I agree. I believe these shares are simply too risky for equity investors at the moment. I’d stay well away.

A more profitable choice

The integration of the outsourcing firms into the UK public sector shows little sign of slowing down. If you would like exposure to this type of business, one stock I would consider is Serco Group (LSE: SRP).

Serco shares received a boost last week, when the firm said that profits for 2018 are now expected to be ahead of previous guidance. Revenue of £2.8bn is expected to generate an underlying trading profit of £90m-£95m, up by about 30% on last year’s figure of £70m.

Another attraction is that chief executive Rupert Soames has already bitten the bullet and raised cash to reduce debt. As a result, his firm’s balance sheet now looks quite reasonable. Net debt should be less than 1.5x EBITDA this year, which seems comfortable to me.

A long-term buy?

Serco stock currently trades on a forecast P/E of 25, falling to a P/E of 21 for 2019. This may seem pricey, but the group’s profits are recovering from historically low levels.

Mr Soames is taking care to rebuild this business with solid foundations and sustainable profit margins. Dividend payments are expected to restart next year and I believe several more years of strong profit growth should be expected.

In my opinion, Serco shares could be an excellent buy-and-hold pick at current levels.

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.

Roland Head 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.

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