Value investing is about buying stocks when they’re trading at bargain prices. But the fact that a company’s share price has been falling doesn’t automatically mean it’s cheap.
For value investors, shares are ‘cheap’ when they’re trading below their intrinsic value. This means cheap compared to the cash the underlying business will produce.
So which stocks are undervalued at the moment? In a volatile market, there are two that stand out to me.
J D Wetherspoon
J D Wetherspoon (LSE:JDW) is top of my list. At a price of £5.78, the company’s free cash flow of 17p per share in 2022 doesn’t look like a lot at first sight.
I think this is misleading, though. There are a number of one-off investments that the business made in 2022 that are making its future cash flows look lower than they’re likely to be longer term.
The business spent £86m on one-off investments that shouldn’t turn into ongoing costs. Around £26m was invested in acquiring freeholds and just under £60m was spent on new pubs and extensions.
Without those costs, free cash flow per share would be closer to 84p per share. That means the free cash flow yield going forward is likely to be around 15%, which makes the stock look cheap.
The most obvious risk with J D Wetherspoon is the amount of debt on its balance sheet. But I think the investments it has been making in its pubs mean this is unlikely to be a significant problem.
With my value investing hat on, this is a stock I’m taking very seriously. I’ll be watching the trading report later this week with a view to updating my data and buying the stock.
Lloyds Banking Group
Lloyds Banking Group (LSE:LLOY) shares also look like a bargain to me. The stock has been caught up in the volatility around the banking sector at the moment, but I think there’s real value here.
As far as I can see, there’s no suggestion that Lloyds could face the kind of liquidity issues that caused problems for SVB Financial. That’s not to say there’s no risk at all.
The potential risk is that panic across the banking sector causes customers to withdraw their deposits out of fear. But I don’t think this is a big issue for Lloyds – and it might even be a benefit.
My suspicion is that fear is likely to set in among smaller banks first. In times of stress, customers are more likely to put their trust in bigger (and more globally significant) banks.
As one of the UK’s biggest banks, Lloyds certainly fits the bill here. So I actually think it could emerge from the crisis stronger than it was before.
Right now, the stock trades at a price-to-book (P/B) ratio of 0.75. In other words, £1 of shareholder equity in Lloyds is on sale for 75p.
To me, this looks like a great opportunity. I’m hoping the share price stays down long enough to give me enough time to make a meaningful investment.
