1 value stock I’d buy and 1 I’d sell

A low P/E rating doesn’t necessarily mean a bargain. One Fool explains why he’s sceptical of flattering headline figures and introduces a stock with a wonderful track record.

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When considering an investment in marketing companies, investors should be sceptical of the headline figures. The industry’s core skill is amplifying the attractiveness of a product or brand, so it should come as no surprise that some companies in the sector polish up their own performance. 

M&C Saatchi’s (LSE: SAA) half-year report points out that “headline results” is not a defined term under International Financial Reporting Standards, meaning the finance department can decide what costs to exclude without restriction. 

There is a vast gulf between the statutory and headline figures reported today and I believe this could be a hindrance, not a helping hand, for investors trying to understand the business. Have a look at the impact of adjustments:

  • Headline profit before tax increased 17%
  • Statutory profit before tax decreased 10%

A few perfectly legal omissions have been applied to supposedly present a more accurate picture of business performance, including share-based payment expenses. In the first half of this year, these totalled £6.85m. That’s a significant cost and I’d be ok with the exclusion it if it truly was a one-off, but it seems to be a regularly incurred cost.

Last year, for example, the company excluded nearly £8m in share-based payment charges from headline profits. This helped it present headline profit before tax as up 18%, compared to actual profit before tax which dropped roughly 46%.  

That said, the company is making advancements. Revenue grew 21%, or 12% at constant currency, and this is reflected in the 15% increase in the interim dividend. However, I’ll be avoiding M&C Saatchi because I just can’t get comfortable with the accounting practices or the balance sheet, which is dominated by intangible assets. 

The power of borrowed brands

A stock I’m far more interested in is Character Group (LSE: CCT). At last count, this £97m market cap toymaker had net cash of £18.6m and traded on a P/E of just under 10.

Character cashes in on the power of brands like Disney, Bob the Builder, Peppa Pig and — most recently — Pokémon, through licensing agreements. It then designs quality toys based on these IPs and outsources manufacturing.

This approach has turned it into a capital-light cash cow. The management team takes care of shareholders via buybacks and dividends too. The shares yield a solid 3% and the share count has reduced from 52.8m in August 2005 to 20.9m today. Buybacks on that scale can be a huge driver of shareholder returns. The company is still buying today, a great decision given the current low valuation. 

One of the company’s largest clients, Toys R US, was recently granted bankruptcy protection in the US, although Character Group has admitted it is still unsure how this will impact its business going forward. I’m not too worried about this short-term blip and believe any downside is more than priced-into the aforementioned dirt-cheap valuation.

Shares in the company are up 280% over the last five years and that return doesn’t include dividends.

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.

Zach Coffell has no position in any of the 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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