Buying quality stocks when they’re temporarily hated can be a recipe for riches, but finding true bargains is easier said than done. Many are cheap for a reason.
One company that continues to fall into the latter category, in my opinion, is FTSE 250 constituent Royal Mail (LSE: RMG).
Back in November, I suggested that its chunky dividend yield wasn’t worth the risk of further price declines. Nothing has occurred in the time since to change my mind. Indeed, I’m beginning to think a dividend cut is now more likely than ever to feature in new CEO Rico Back’s strategy for the company when it’s revealed in March.
Tuesday’s trading statement — covered by my Foolish colleague G A Chester — was poorly received by the market and resulted in another steep decline in the share price.
Having lost a little over 55% in value since last May, Royal Mail’s shares now trade on a little below 10 times earnings (based on expected EPS of 27.1p). Considering the structural decline of its letters business and concerns over competition from parcels-focused rivals, that still looks too high.
Value hunters should wait until later in the year before re-assessing the investment case, I feel.
But Royal Mail isn’t the only stock in the second tier I’d continue to steer clear of.
Broadband provider Talk Talk Telecom (LSE: TALK) is potentially an even worse pick, despite lots of chat about rising customer numbers in today’s Q3 trading update.
Talk Talk saw its customer base grow by 44,000 over the period. When combined with data from the other two quarters, the company has now added 148,000 accounts to its books in the financial year to date. Considering that it was forecasting “in excess of” 150,000 for the 2018/19 year as a whole, that’s pretty good going.
Total headline revenue over the three months to the end of December also rose 2.9% to £386m, although the amount of money made from each customer fell by 2% to £24.70 compared to the previous year.
Looking ahead, the firm said that it was still “confident” of strong earnings growth in FY20 thanks to “customer momentum and cost savings” — the latter the result of the ongoing reorganisation of the business.
Nevertheless, accounting adjustments and further investment in order to lure customers have led Talk Talk to state that underlying profit for this year is now likely to be between £245m and £250m — down £10m-£15m on the consensus estimate from city analysts. This goes some way to explaining why the share price has fallen again this morning.
Away from today’s numbers, I also continue to be wary of the mid-cap’s balance sheet.
Talk Talk had £800m in net debt at the half-year point, almost two-thirds what the company is worth today. That’s too big a burden for me.
Dividends, while safely covered by profits, aren’t exactly attention-grabbing either.
The company is forecast to return 2.5p per share this year, equivalent to a yield of 2.4% at a share price of 103p. As far as I’m concerned, you could get far more from considerably better businesses elsewhere.
All this, when considered alongside the fact that Talk Talk’s shares traded on a pretty dear 20 times earnings before this morning (despite being in derisory form for many years), suggests that the company continues to offer pretty poor value as an investment.