The Motley Fool

Why I’d dump Interserve plc to buy this market-beater

2017 has been terrible for shareholders of Interserve (LSE: IRV) as the company has lurched from one profit warning to another. 

Indeed, this year the outsourcer has issued two severe profit warnings and investors have rushed for the exit sending the shares down more than 70% year-to-date. 

Sign up for FREE issues of The Motley Fool Collective. Do you want straightforward views on what’s happening with the stock market, direct to your inbox? Help yourself with our FREE email newsletter designed to help you protect and grow your portfolio. Click here to get started now — it’s FREE!

And it doesn’t look as if the company will be able to solve its problems anytime soon. That’s why I think it could be time to dump the shares and reinvest the proceeds in one of the market’s best growth stocks. 

Brewing troubles 

Interserve’s problems stem from the company’s business model as it has to bid on contracts, offering the lowest price to beat competitors. Unfortunately, this means profit margins are usually razor thin, leaving little room for error. 

Interserve’s current problems stem from cost overruns in its Energy to Waste business. To try and draw a line under the scenario, management has decided to exit this business at the expense of £160m. But once again, costs have got out of hand, and final costs are now expected to “significantly exceed the £160m currently provided.

As losses have risen, investors have become worried about Interserve’s debt, which management believes will increase to between £475m and £500m by the end of the year. Managment tried to reassure investors about its financial position within the last profit warning noting that “group will be able to operate within its banking covenants for the year ended 31 December 2017.” However, it looks as if the market does not believe this statement.  

Overall, it’s unclear what the future holds for Interserve and its investors, but rather than sticking around to find out, I believe shareholders should jump ship, and re-invest money into Domino’s (LSE: DOM) instead. 

Cash is king 

Unlike Interserve, Domino’s has fat profit margins. Last year the company reported an operating profit margin of 23% (compared to Interserve’s -2.3%) and return on equity of 74%. Free cash flow per share for the year was 8.1p or around £40m. Of this free cash flow, Domino’s returned £37m to investors via dividend payouts and £25m via a share buyback for a total cash return of £62m. 

Today the company announced a further cash return to investors. Management has decided to initiate a new £15m buyback, alongside the current dividend yield of 3.4%. 

Beating the market 

Domino’s has managed to grow earnings per share at a staggering 18.7% per annum for the past six years, and this growth, coupled with the company’s cash returns policy, means that the shares have smashed the wider market. 

At the time of its IPO in 1999, shares in Domino’s were worth a split-adjusted 8.3p. Today, they’re worth 287p, and the annual dividend is worth 8.8p. This means that excluding dividends, over the past 18 years the shares have returned 3,358% excluding dividends. Over the same period, the FTSE 250 has returned 260%. 

I believe that as Domino’s continues to grow and return cash to investors, it can repeat the performance of the past two decades. City analysts have pencilled in earnings per share growth of 5% for 2017 and based on these estimates, the shares trade at a forward earnings multiple of 18.8. This might seem high, but considering the company’s historical growth, I believe it’s worth paying such a premium. 

Tips to help you make a million

Domino's has made millions for its shareholders since its IPO at the turn of the century and if you're interested in other companies that could produce the same returns, the Motley Fool is here to help. 

We've put together this free report, which is designed to help you improve your investment returns in just 10 easy steps

What have you got to lose? Click here to download for free today.

Rupert Hargreaves does not own any share mentioned. The Motley Fool UK has recommended Domino's Pizza. 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.