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2 ‘bargain’ stocks I’m avoiding at all costs

When it comes to investing, knowing which stocks to steer clear of can be just as important as finding those capable of turbocharging your wealth. With this mind, here are two companies I’ve avoided to date and — based on today’s market updates — will continue to do so.

Debt-laden

Despite rising to a peak of 430p almost two years ago, shares in roadside recovery specialist AA (LSE: AA) are now trading nearer to levels seen when it first arrived on the market in 2014. Based on today’s annual results — and despite a positive reaction from the market — I don’t expect this state of affairs to change dramatically over the short term.

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Admittedly, the numbers weren’t bad when compared to previous years. In 2016/17, revenue climbed 1.6%,with roadside revenue growing 2.5% to £742m thanks to 4,000 new members being added. Profits after tax rose to £74m (from a £1m loss the year before) with net cash flow after dividends now positive at £42m. Elsewhere, the company reported that its digital offering was “revolutionising” the customer experience, with its new app — downloaded by more than a million members — being used in 22% of breakdowns.

Yours for just 11 times 2017 earnings, AA’s stock also comes with a 3.7% yield. So, why am I still bearish on the stock? In one word: debt.

Sure, the company does appear to be making progress on this front, having sold off its Irish business to private equity group Carlyle in 2016 for £130m. Recent refinancing will save the company £10m of the annual cost of borrowing and a larger amount of cash flow should be available once capital investment has been reduced.

Nevertheless, at £2.7bn, AA’s debt pile remains significantly higher than its £1.6bn market cap. With so many financially robust companies available on the market, I’m not sure its prospects justify the patience required.

Pricing pressure

Today’s trading update from £.1.4bn cap Thomas Cook (LSE: TCG) was a mixed affair, perhaps explaining why its shares are trading slightly lower this afternoon.

Having sold 90% of its programme, the winter season is “closing out as expected” according to the company. Booking levels were similar to those experienced in 2015/2016 with growing demand for holidays to Spain and the Dominican Republic making up for weaker sales to destinations such as Turkey.

Looking forward, summer bookings are up 10% (42% sold) with particularly strong growth in Greece (+40%). Trading in Northern and Continental Europe is also looking positive, with both markets currently registering double-digit growth. On a less encouraging note, bookings to the Spanish Islands have “levelled off” due to intense competition after performing strongly in 2016.

It’s a similar story for its airline operations. While a refocusing on selected routes has resulted in a sizeable increase in bookings, the company did warn that “pricing across both short and long-haul destinations remains weak“.

Like AA, shares in Thomas Cook trade on a temptingly low valuation of just under nine times 2017 earnings. A price-to-earnings growth (PEG) ratio of just 0.47 also suggests that prospective investors are getting a cracking deal based on expectations of future performance.

That said, I still see no reason to modify my view that Thomas Cook’s market share will continue to be eroded by online competitors with far more flexible business models. Based on today’s update, a return to form is still a long way off.

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Paul Summers 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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