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Why I’d sell Purplebricks Group plc to buy this unloved small-cap stock

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Shares of online estate agent Purplebricks Group (LSE: PURP) have recovered in recent week, climbing by more than 27% from their November low of 310p.

Fans of the stock, including fund manager Neil Woodford, are probably relieved. But is now the right time to be buying, or should shareholders think about locking in some profits?

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The good news

The only part of the group’s business that’s operating profitably at the moment is its UK division. UK sales rose by 118% to £39.9m during the first half of the group’s current financial year, lifting the division to an operating profit of £3.2m.

The company’s other operating divisions (USA and Australia) are still operating at a loss, but that’s to be expected as they’re still in the early stages of development.

This is why I’d sell

Purplebricks has faced questions about its business model and accounting, but in my view the most serious concern for investors is the firm’s valuation. The shares currently trade on 14.5 times sales and a whopping 247 times 2018/19 forecast earnings.

Property portal Rightmove also trades on about 15 times sales. But it has an operating profit margin of more than 70%. Purplebricks’ operating margin in the UK was 8% during the first half of its current financial year. Overall, it made a loss.

The costs of rolling out Purplebricks’ business model appear to be considerable. Administrative costs in the UK rose by 144% during the first half of last year, even though sales only rose by 118%. Remember, although it has no branches, it still has lots of local agents.

I don’t think that it will ever enjoy the kind of profit margins achieved by Rightmove. In my view, the group’s current valuation leaves little room for further gains and means that shareholders have no protection against any kind of disappointment.

Although this may be a great business, I’d rate the shares as a sell at current levels.

One consumer stock I’d buy

If you’re looking for investments with exposure to the UK economy, I believe car dealership group Cambria Automobiles (LSE: CAMB) could be a more interesting opportunity.

The firm’s shares edged lower today after it released a year-end trading update. Like-for-like new car sales fell by 14.6% during the five months to 28 February, but some of this decline was offset by flat used car sales and a 6.1% increase in like-for-like after-sales.

It’s important to remember that new car sales are the least profitable part of a dealership business. After-sales is by far the most profitable activity.

Taking a stronger position

One way to improve the profitability of a car business is to head upmarket, where volumes are lower and margins are higher. And where after-sales are very expensive indeed.

That’s what Cambria is doing at the moment. Over the last five months, the firm closed two body shops, plus Honda, Alfa Romeo and Jeep dealerships. To replace these, it’s opened two Bentley dealerships, a McLaren showroom and — shortly — a Lamborghini operation.

The shares look cheap to me at the moment, on just eight times forecast earnings. Although the outlook for the new car market remains uncertain, Cambria’s £63m market cap is supported by £49m of fixed assets and a net cash balance. In my view, this could be a relatively low-risk buy at current levels.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK owns shares of Cambria Automobiles. The Motley Fool UK has recommended Rightmove. 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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