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Got £1,000 to invest? Here’s one FTSE 250 stock I’d buy, and one I’d avoid

There are a lot of recovery stocks on the UK market right now. Contrarians will see this as an opportunity but, as ever, stocks don’t fall for a reason. So watch out for the threats, as well as the opportunities.

AA

Motoring breakdown and insurance group AA (LSE: AA) has seen its share price fall by a thumping 45% over the past 12 months, and 77% over five years, as profits have been squeezed by tough competition in its key markets.

A flurry of directorship purchases earlier this year encouraged investors, while the FTSE 250 group’s August update pointed to a return to growth and strong free cash flow, amid positive operational momentum and a stabilisation in its paid membership base. Optimists hoped a three-year contract to offer the AA’s services to Admiral customers marked a turning point. 

Today, the AA share price is up slightly after its interims to 31 July showed a first-half performance in line with expectations, with the group “on track to deliver trading EBITDA growth and strong cash flow generation” over the full year.

CEO Simon Breakwell said the roadside business has stabilised its personal membership base, which should be broadly flat this year, and return to growth next, while its insurance business continues to generate strong rates of profitable policy growth, which he expects to continue in the second half.

Pre-tax profit jumped 50% to £42m, although operating profit rose just 3% to £120m. Revenues climbed only 2.3% to £491m. 

AA’s stock is up 47% measured over three months, so the share price recovery has already begun. However, its net debt stood at a mighty £2.7bn recently, which is massive for a company only valued at £424m. That largely explains its lowly valuation of 4.5 times future earnings, and will scare away anybody with a passing knowledge of Thomas Cook. On that note, I think I’ll look elsewhere.

Card Factory

Greetings card retailer Card Factory (LSE: CARD) has also had a rough time, its stock down 16% over one year and 28% over five. Yet I think the group has some immunity from the wider retail slowdown. Cards, gifts and party paraphernalia may seem like fripperies, but people still buy Mother’s Day, Valentine’s Day and birthday cards in a recession.

Today’s interims hailed modest like-for-like sales growth of 1.5%, including a 1.2% increase in store like-for-likes, “outperforming reported negative high street footfall.” The FTSE 250 group opened 26 net new stores, which is driving additional revenue growth and also a sign of confidence. Card Factory also has an online presence, and website sales grew 25%.

The group’s first half investment in supply chain, operations and property management business efficiencies should deliver second-half savings. It’s also struck retail partnerships with Aldi in the UK and The Reject Shop in Australia. CEO Karen Hubbard remains “positive about the resilience of the card market” and the group’s business model. The stock is currently up 2%.

Today’s steady report, and a forecast valuation of 9.7 times earnings, makes it a lot more tempting than the AA, while the yield is a whopping 8.8%, with cover of 1.2. Today, management maintained its special dividend too. The group may struggle for earnings growth in the current climate, but the yield could bring many happy returns.

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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK owns shares of Card Factory. 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.