2 forgotten value stocks with upside potential

These two shares may be cheap without good reason.

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One potential hazard facing investors at the present time is value traps. With the FTSE 100 trading close to its record high, there are now fewer stocks offering bargain-basement valuations. This means that those which offer wide margins of safety may do so for good reason. In other words, their outlooks may be relatively unfavourable.

While value traps can cause disappointing investment performance, there are still some stocks which could offer a potent mix of growth potential and low valuations. Here are two companies that could fall into that category.

Improving performance

Housing support services company Mears (LSE: MER) reported a trading update on Tuesday. It showed that the company is making solid progress in both of its core divisions. In Housing, it continues to perform well and this is good news for the company’s investors, since it accounts for 83% of its revenue. It has achieved 96% visibility of consensus revenue forecast for 2017, while operating margins are currently in line with previous expectations.

In the company’s Care business, market conditions have remained challenging. Despite this, underlying trading has shown improvement month-on-month through the first half of the year, with management expecting this trajectory to continue. Although the Care division is expected to report a loss in the first half of the year, it is forecast to move into profitability in the second half.

Looking ahead, Mears is expected to report a rise in earnings of 18% this year, followed by further growth of 12% next year. Despite this strong growth outlook, it trades on a price-to-earnings growth (PEG) ratio of just one, which suggests that it offers a wide margin of safety. Certainly, its Care business has disappointed recently, but an improving outlook could make the stock a sound buy for the long term.

Uncertain outlook

Also offering a wide margin of safety is recruitment specialist Staffline (LSE: STAF). It has reported five consecutive years of rising profitability, with more growth expected over the next two years. Despite this, the company trades on a price-to-earnings (P/E) ratio of just 11.2. This indicates that the company’s shares could be worth considerably more than their current level even after their 56% rise since the start of the year.

Clearly, Staffline faces a highly uncertain future. The outlook for the UK is difficult to predict and could be negatively impacted by the start of Brexit talks, as well as the minority government, which has now been confirmed. These factors may cause investors to become more risk-off over the medium term, which could lead to valuations which are perhaps slightly lower than they normally would be.

However, with a solid strategy and a sound track record of growth, Staffline appears to have a significant amount of capital growth potential. Although relatively risky, its wide margin of safety suggests that now could be the right time to buy it for the long run.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

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