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We’re approaching February and many investors will be looking at stocks to buy during the month. It can be quite a healthy investment strategy to invest in one or two companies every month, thus spreading some of the risk associated with market timing and helping to smooth out volatility over the longer term.
Rather than attempting to predict short-term market movements, this approach encourages a steady accumulation of high-potential investment — be that a reflection on growth opportunities, valuation mismatch, or dividends.
So what’s on my radar?
Well, I can’t cover the whole market. So I start with a screener, focusing on stocks that appear undervalued relative to their growth outlook, which narrows things down substantially.
Deeply undervalued
One stock that looks deeply undervalued is Jet2 (LSE:JET2) — the UK’s number-one tour operator and third largest airline.
What interests me isn’t necessarily the business or hunch that British people will be booking more holidays because the weather’s been so awful. It’s the valuation. The stock looks pretty cheap on face value. At 6.2 times forward earnings it’s already trading at a discount to majority of peers in the sector — if not all of them.
But this figure rarely means anything on its own. After all, it could be up to its eyeballs in debt or maybe earnings are going into reverse.
That’s not the case here however. Jet2’s actually sitting on a net cash position around £800m (when we subtract deferred revenues), which actually means its trading around 4.1 times forward earnings.
And earnings are forecast to grow, just not this year. The business is investing heavily in a new operating hub at Gatwick. While revenue’s increasing by nearly 10%, earnings will flatline until these start-up costs are through.
Peers just don’t stack up
On this basis — adjusting the price-to-earnings ratio for the net cash or debt position — peers look substantially more expensive. In fact, the average, when including US-listed Ryanair and margin-leading IAG, is around 9.1 times. Taken on face value, this could suggest that Jet2 shares are trading with half the value they should be.
Of course, it’s not quite that simple. Jet2’s definitely undervalued, but its margins aren’t the largest. And while it does have a package holiday arm, it’s less diversified than the likes of IAG which also caters also business and long-haul passengers.
We’ve also got to keep an eye on Jet2’s target audience. It’s primarily price-conscious leisure travellers, including middle-income families, couples, and younger, social-media-savvy audiences. Let’s be honest, the government’s been kind to this group. Pressure on this audience won’t be good for business.
However, the potential for a re-rating vastly outweighs any concerns. The stock’s hugely undervalued, in my opinion, and definitely worth considering.
