The Motley Fool

Cheap UK shares: 1 stock I’d buy and 1 stock I’d avoid

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Graph Falling Down in Front Of United Kingdom Flag
Image source: Getty Images

World stock markets have rallied strongly over the last couple of weeks. The UK’s FTSE All-Share index, for example, has climbed 13% since 30 October. Yet there are still many cheap UK shares for investors to consider.

The two stocks I’m looking at today both trade on single-digit forward earnings multiples. I think one of them could be a genuine bargain, but I’m very wary about the other. Read on, and see if you agree with me!

5 Stocks For Trying To Build Wealth After 50

Markets around the world are reeling from the coronavirus pandemic… and with so many great companies trading at what look to be ‘discount-bin’ prices, now could be the time for savvy investors to snap up some potential bargains.

But whether you’re a newbie investor or a seasoned pro, deciding which stocks to add to your shopping list can be a daunting prospect during such unprecedented times.

Fortunately, The Motley Fool UK analyst team have short-listed five companies that they believe STILL boast significant long-term growth prospects despite the global upheaval…

We’re sharing the names in a special FREE investing report that you can download today. And if you’re 50 or over, we believe these stocks could be a great fit for any well-diversified portfolio.

Click here to claim your free copy now!

Cheap UK shares #1

The share price of roadside assistance firm AA (LSE: AA) has outperformed the wider market so far this month. At 28.8p, it’s up over 25%.

Nevertheless, it remains at a huge discount to its historical levels. On a one-year view, it’s 40% below. And, over three and five years, down 82% and 89%.

Yet the company said in its latest interim results it had delivered “a remarkably strong performance in the first half.” It also reiterated its full-year guidance for an outturn “only slightly below that of the prior year.”

The shares are trading at an extraordinarily low 2.2 times forecast earnings. Surely this has to be one of the biggest bargains in the market?

Why I’d avoid AA

AA’s problem is its huge debt pile. And this, in a nutshell, is why I’d avoid the stock. At the half-year end, net debt stood at £2.6bn — an eye-watering 7.3 times trailing 12-months EBITDA. Meanwhile, shareholders’ equity was negative to the tune of £1.6bn.

Too right the company is “continuing to review a range of potential refinancing options, including the possibility of raising new equity.” This in addition to continuing discussions with a private equity consortium “regarding a possible all-cash offer.”

Given the dire state of the balance sheet, I can’t see the existing equity being valued anything much above its current price in the market (market-cap £180m) in a refinancing or cash offer. And there are scenarios in which it could wind up being valued a lot lower.

Cheap UK shares #2

Support services firm Capita (LSE: CPI) has also outperformed the wider market in recent weeks. Its shares have surged almost 60%, helped by a “resilient” trading update last Tuesday.

Nevertheless, like AA, the company’s share price is still heavily down from a year ago (74%), as well as over three years (87%) and five years (95%). At a current price of 39.17p, it’s market-cap is £654m, and it’s valued at 6.1 times forecast earnings.

Why I’d buy Capita

Capita’s balance sheet isn’t exactly strong. But it’s a lot less scary than AA’s. Net debt is much lower at £1.1bn, as is gearing at 2.7 times EBITDA. And while shareholders’ equity is negative, at £139m, this too is considerably less grim than AA’s.

I’ve been impressed by Capita’s progress since a boardroom clearout a few years ago. The Covid-19 pandemic has delayed but not derailed the progress of the turnaround, in my view.

On this basis, along with the cheap earnings multiple and better-than-beastly balance sheet, I reckon the shares are very buyable at their current level. I think the stock has strong credentials as a higher risk/higher reward pick for a diversified portfolio.

There’s a ‘double agent’ hiding in the FTSE… we recommend you buy it!

Don’t miss our special stock presentation.

It contains details of a UK-listed company our Motley Fool UK analysts are extremely enthusiastic about.

They think it’s offering an incredible opportunity to grow your wealth over the long term – at its current price – regardless of what happens in the wider market.

That’s why they’re referring to it as the FTSE’s ‘double agent’.

Because they believe it’s working both with the market… And against it.

To find out why we think you should add it to your portfolio today…

Click here to get access to our presentation, and learn how to get the name of this 'double agent'!

G A Chester 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.

Our 6 'Best Buys Now' Shares

Renowned stock-picker Mark Rogers and his analyst team at The Motley Fool UK have named 6 shares that they believe UK investors should consider buying NOW.

So if you’re looking for more stock ideas to try and best position your portfolio today, then it might be a good day for you. Because we're offering a full 33% off your first year of membership to our flagship share-tipping service, backed by our 'no quibbles' 30-day subscription fee refund guarantee.

Simply click below to discover how you can take advantage of this.