Head To Head: G4S vs Serco

Published in Investing on 20 November 2012

Which blue-chip security group should you buy today -- G4S (LSE: GFS) or Serco (LSE: SRP)?

In this series, some of your favourite FTSE 100 (UKX) shares go head to head in a three-round contest for superiority.

In Round 1, the firms fight on earnings; in Round 2, on dividends; and Round 3 is a battle of the balance sheets. The winner will be the company that has racked up most points at the end of the contest.

Stepping into the ring today are security giant G4S (LSE: GFS) and Serco Group (LSE: SRP), a company with significant security elements to its operations, including involvement with military forces, intelligence agencies, immigration and border security, and prisons.

Serco's shares have matched the FTSE 100 over the past six months, both having risen 4%, while G4S's shares have tumbled 12% in a period that included the company's staffing debacle for the Olympic Games.

Let's take our seats at ringside.

Round 1: earnings

Recent share price244p550p
Last year price-to-earnings (P/E) ratio10.713.9
Current year forecast P/E10.713.5
Four-year earnings per share (eps) compound annual growth rate (CAGR) (%)1421
Current year forecast eps growth (%)03
Forecast operating margin (%)4.95.5

Source: Digital Look. Winners in bold.

The two companies are closely matched, but Serco edges the first round by taking the final point for its superior operating margin.

Round 2: dividends

Last year dividend yield (%)3.51.5
Current year forecast dividend yield (%)3.61.6
Four-year dividend CAGR (%)1519
Current year forecast dividend growth (%)26
Forecast dividend cover2.64.6

Source: Digital Look. Winners in bold.

It's a similar story in round two. Again, the companies are closely matched, and again Serco edges the round by taking the final point: in this case, for more conservative dividend cover.

Round 3: balance sheet

Price-to-book (P/B) ratio2.22.7
Net gearing (%)12063

Source: Digital Look. Winners in bold.

The final round ends all square and Serco emerges as the winner of the contest, having won two rounds and drawn one. The overall points tally is Serco seven and G4S five.

Post-match assessment

Serco and G4S have delivered strong historic earnings and dividend growth, Serco being particularly strong on these measures. However, analysts' forecasts are for markedly lower growth this year, although Serco again comes out ahead of G4S. It's also notable that Serco has the stronger business fundamentals in terms of operating margin, dividend cover and gearing.

However, on the question of which stock is the better buy today, it's hard to ignore the fact that G4S took all the points on the five valuation measures I use in these head-to-head articles: historic and forecast P/E, historic and forecast dividend yield and P/B.

On the face of it, this suggests that G4S might just be better value than Serco at the present time. To some degree, performance will depend on how great a knock-on effect there is to G4S's future contract bids after its Olympics blunder -- and how much Serco benefits. In my experience, though, crises of the species G4S has gone through usually have a surprisingly short-term impact.

At the end of the day, I think G4S's relatively low P/E could be attractive for long-term investors, who are also set to receive a reasonably healthy 3.6% dividend yield while waiting for G4S to get back to business as usual.

Top City investor Neil Woodford -- the man whose funds have outperformed the market by more than 300% over the past 15 years -- holds both companies in his portfolios.

You can learn about Woodford's enormously successful investing strategy and the other dividend-paying blue chips he currently favours in an exclusive Motley Fool report, 8 Shares Held By Britain's Super Investor. The report is free to download right now: simply click here.

> G A Chester does not own shares in any of the companies mentioned in this article.

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The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

Excel35 20 Nov 2012 , 4:24pm

The loser on rounds is actually the better one to buy????

Woodford owns both of these, I'm surprised you didn't mention.

richjfool 21 Nov 2012 , 10:33am

GFS pays 2% more yield, so the round is given to Serco because it has a higher dividend cover. The scoring in these head to heads seems rather subjective to me.

M0byDick 21 Nov 2012 , 10:56am

Hi folks

The idea in these head-to-head articles is to get a feel for the relative strengths of the companies. A range of measures is used that can be broadly divided into 'business fundamentals' (margins etc) and 'share valuation measures' (P/E etc). No set of such measures will ever be perfect and where anomalies arise I try to highlight them. I do give my own (subjective) view on the overall picture, and of course readers are free to disagree with me :)

Foolish best
MobyDick (G A Chester - article author)

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