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I was sitting in the pub the other evening, when our friends decided to quiz me on what US or UK stocks they should be buying. I’m always incredibly hesitant to provide anything that might be construed as an investment recommendation — not just because the rules around financial advice are strict.
But one thing struck me, so many people pick stocks depending on whether they think the company’s going to do well or whether they like the products or services they provide. This can be part of the equation, but on it’s own this doesn’t constitute an investment thesis.
I believe every investment idea should start with the numbers, ratios and metrics. Building on that, a cheap stock’s not necessarily one that’s seen its share price fall — shares dip for good reasons. It’s about whether the company’s share price is reasonable or cheap versus its expected earnings, sales, and margins.
What’s cheap?
Cheap is always relative. Stocks are very hard to compare across sectors. For example, US tech stocks trade, on average, around 24 times forward earnings. UK airlines trade on average around six times forward earnings.
The reasons for this divergence are quite simple when you think about it. One is the growth engine of the global economy with long-term secular drivers, and margins are typically strong. The other is cyclical, and margins are typically narrow.
So with that in mind, here are some stocks on my watchlist because I consider them to be cheap compared to their peers.
| P/E (next year) (x) | P/E (second year) (x) | Net debt (£) | Dividend yield | |
| Arbuthnot Banking Group | 8 | 6.7 | 5.7% | |
| Character | 9.6 | -15.6m | 5.1% | |
| Jet2 (LSE:JET2) | 6.6 | 6.2 | -2bn | 1.2% |
| Synectics | 10.6 | 9.3 | -10.4m | 1.8% |
| Yu Group | 7.6 | 7.1 | -109m | 4.4% |
Undervalued by 45%?
Jet2’s by no means the perfect company. Its margins are relatively thin due to operating an older and less efficient fleet — currently being overhauled — and the government’s latest cash-raising exercises have hurt businesses. This does mean its earnings are less resilient than its major carrier peers.
However, the valuation’s impressive. It’s currently trading around 6.6 times forward earnings. However, the most impressive part in the balance sheet. Including customer deposits, it’s sitting on more than £2bn in net cash. That’s a huge figure for a company with a market-cap of £2.5bn.
It other words, the company’s trading at just over one times net earnings for the coming year. The caveat, of course, is that nearly half of this net cash figure is made up of customer deposits that need to be delivered upon. However, I still find these cash-adjusted metrics very compelling. Institutional analysts agree — it trades 45% below the average share price target as compiled by analysts.
The risks? Well, as noted, margins aren’t phenomenal. If the government tries to raise the Minimum Wage or stealth taxes, there could be more pressure.
However, I certainly think this is a stock worth considering.
