The Motley Fool

Forget the FTSE 100, I’d buy shares in these FTSE 250 growth stocks instead

If you’re investing for retirement, you probably won’t go far wrong if you drip-feed cash into a FTSE 100 tracker fund each month. The big-cap index certainly looks a reasonable buy today, with a price/earnings ratio of 12, and a 4.3% dividend yield.

However, the FTSE 100 is currently only worth 6% more than it was five years ago. Although dividends will have added about 20% to that figure, it still looks pretty average to me. If you’re willing to do your own research and invest in individual stocks, I believe you can enjoy much bigger gains.

A takeaway success

In my view, one of the best places to start your search is the FTSE 250 mid-cap index. Companies of this size are generally profitable and established, but still small enough to deliver attractive growth.

A good example is Domino’s Pizza Group (LSE: DOM). Over the last five years, Domino’s share price has risen by 66% — roughly 10 times the increase seen in the value of the FTSE 100.

Although the shares have fallen over the summer, October’s third-quarter trading update seems to have reassured the market that this growth business remains on track. The figures showed that sales rose by 6% to £303.3m during the third quarter. Management said that another £25m would be spent buying back the group’s shares.

Buy, sell or hold?

One challenge facing the business is that the UK market is already fairly mature. Most towns already have a Domino’s. In order to continue expanding, management is splitting many existing franchise territories into smaller areas, to create space for new stores.

It’s too soon to say how successful this will be. There’s a risk that if territories become too small, franchisees may be reluctant to invest in new stores.

In my view, this risk is probably already reflected in the group’s share price. Domino’s shares trade on about 16 times 2018 forecast earnings, with a dividend yield of 3.5%. Debt looks manageable, and continued buybacks should support earnings per share growth. Still worth buying, in my view.

This could be big

The share price of online travel firm On The Beach Group (LSE: OTB) was up by 5%, at the time of writing, after the group said that sales rose by 24% to £104.1m during the year ending 30 September.

Although much of this growth came from the acquisition of the Classic Collection Holidays business in August, core revenue from and rose by 9% to £89.3m. Pre-tax profit rose by 23.7% to £26.1m.

Travel firms suffered this summer as hot weather in Northern Europe encouraged people to take staycations. Many tour operators were forced to discount heavily in order to fill hotels.

Fortunately, On the Beach’s online-only business model meant that instead of competing for heavily-discounted sales, it was able to cut advertising spending in some areas, reducing costs. As a result, the group’s operating profit margin was virtually unchanged last year, at 25.2%.

A long-term buy?

The company’s brand is less well known that some rivals, but it’s gaining strength. Last year, 63.9% of web traffic came from free or branded searches, compared to 59.3% the year before.

Analysts expect earnings to rise by 22% to 25.9p per share in 2018/19. This puts the stock on a forecast P/E of 16.3 after today’s gains. At this level, I believe On the Beach deserves a buy rating for long-term growth.

You Really Could Make A Million

Of course, picking the right shares and the strategy to be successful in the stock market isn't easy. But you can get ahead of the herd by reading the Motley Fool's FREE guide, "10 Steps To Making A Million In The Market".

The Motley Fool's experts show how a seven-figure-sum stock portfolio is within the reach of many ordinary investors in this straightforward step-by-step guide. Simply click here for your free copy.

Roland Head has no position in any of the shares 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.