The share price of embattled online white goods retailer AO World (LSE: AO) is up over 10% today as the company announced a 16.6% year-on-year rise in sales for the quarter to December. However, even after this solid performance, AO World is still one growth share I’d steer clear of in 2018.
My primary reason is that its business model of selling white goods online, while offering the possibility of improved margins compared to bricks and mortar competitors, puts it in a highly competitive sector that is utterly reliant on solid economic growth.
In addition to this, AO’s stock is currently valued like an up-and-coming tech one, not a boring old electronics retailer. The company’s current market cap is £600m against half-year operating losses of £12m that are increasing as the firm expands into Europe and ramps up marketing expenditure in the UK.
And although UK operations are now marginally profitable after years of operation, they only produced £2.5m in operating profits for the half year to September on some £316.8m in revenue. Indeed, these operating profits were a full 73% lower than the year before due to the aforementioned investments in increasing brand awareness. Add in the losses from expanding European operations and I see little prospect for sustained profits in the near term.
With low margins, high competition and an astronomical valuation, I see plenty of better places to invest my cash than a highly cyclical retailer such as AO World.
Serving up a heaping plate of profits
I’m much more interested in FTSE 100 catering giant Compass Group (LSE: CPG). As corporations the world over look to trim operating costs and focus solely on their core competencies, Compass is a major winner as it offers customers such as schools, hospitals and corporate HQs the opportunity to outsource the costly business of running cafeterias.
In the year to September this trend continued apace as Compass notched up organic revenue growth of 4% to £22.9bn, driven by further inroads into the highly profitable North American market. A laser-like focus on operational efficiencies meant operating profits grew by an even greater 5.6% to £1.7bn during the year.
Management sees further scope to improve these metrics, particularly as margins in the US are significantly higher than those elsewhere and a rebound in oil prices should lead to a rebound in demand for its services in oil camps the world over.
Another reason I like Compass is that the group’s sales are largely defensive as its customers will by and large require food offerings throughout the economic cycle. This allowed management to return gobs of cash to shareholders last year through a regular dividend of 33.5p and a special payout of 61p that together yielded a whopping 6.1%.
Of course, FTSE 100-beating dividends, non-cyclical growth, rising margins and a long history of market-outperformance mean Compass shares trade at a premium valuation of 20 times forward earnings, but I believe this is a fair price to pay for these characteristics and solid growth prospects over the long term.
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Ian Pierce has no position in any of the shares mentioned. The Motley Fool UK has recommended Compass Group. 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.