5 reasons the market might be undervaluing this FTSE 250 stock

FTSE 250 stock Marks and Spencer looks cheap based on earnings multiples and other qualitative factors. Is the market overlooking this?

| More on:

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.

Mature Caucasian woman sat at a table with coffee and laptop while making notes on paper

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The price of FTSE 250 stock Marks and Spencer (LSE: MKS) has been trending higher over the last couple of months. But, given it is well below its all-time high, I do think there might be reasons to believe the stock is undervalued.

An obvious place to start is with the company’s price-to-earnings (P/E) ratio and that of its peers.

Price-to-earnings ratios

Food and drug retailers listed on the London Stock Exchange have an average P/E ratio of 12.3 and for a diversified retailer, it’s 11.1. A weighted average of these two would be a good point for comparison. Since Marks and Spencer’s gets about 34% of its revenues from clothes and homeware, and 66% from its food business, those are the weighing factors.

The weighted average comes out at 11.5. Marks and Spencer’s P/E ratio is quoted at 10.4, so it looks undervalued.

Food glorious food

The company’s average operating margin of 3.9% in its food division is better than competitors like Aldi and Co-Op, which score 2.1% and 2.8% respectively. Those mouth-watering adverts seem to have done their job. Customers seem to be willing to pay a little more for treats at M&S Food. The tie-up with Ocado should help get the company’s food into more online baskets.

Suited and booted

A third of Marks and Spencer’s business is clothing and homeware. This has an average operating margin of 9% compared to 5.7% for House of Fraser. But it’s well behind the likes of Next, which gets 18.2%. Next does twice as much business online as it does in-store, which might explain the difference.

The good news is that Marks bought the technology of the now-defunct Thread.com. It gave personal stylist recommendations to online clothes shoppers based on their inputs and purchases. If integrated correctly, this could help drive online sales higher.

A well-known FTSE 250 stock

According to YouGov, Marks and Spencer is the most popular and fifth most famous home and department store in the UK. It scores well for popularity across generations compared to its peers, which is encouraging. I think this is a good sign for the company as it is easier to build awareness than it is popularity.

It is also a well-known food brand. However, it didn’t score as well when it came to the popularity of its food. It was more popular than some of the large supermarkets. But, It fell behind the discount supermarkets like Aldi and Lidl, which scored well. I think the survey might have focused on value for money. The M&S Food brand is built on being a cut above the usual in terms of quality but not necessarily cheaper.

Restructuring

Group operating margins declined from 13% in 2008 all the way to 2% in 2018. After years of restructuring, they are up to 5%. But they are still lower than individual businesses’ margins would suggest. That’s because adjusting and exceptional items are still being expensed at the group level, lowering the margins. It does not appear that restructuring is over yet.

It might well be that Marks and Spencer’s shares look undervalued because of uncertainty about the length and ultimate success of what is a bold and extensive restructuring plan. But, I am encouraged about the uptick in margins.

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.

James McCombie has positions in YouGov Plc. The Motley Fool UK has recommended Ocado Group Plc and YouGov Plc. 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.

More on Investing Articles

Investing Articles

Empty Stocks and Shares ISA? I’d snap up these 3 stocks to start with!

Sumayya Mansoor explains how she would start to build wealth from scratch with an empty Stocks and Shares ISA and…

Read more »

Concept of two young professional men looking at a screen in a technological data centre
Investing Articles

7.7% yield and going cheap! Why is this unknown FTSE 250 stock flying?

It's no household name, but there's one FTSE 250 stock with a high dividend yield and booming profits that looks…

Read more »

Photo of a man going through financial problems
Investing Articles

I’d stop staring at the Nvidia share price and buy this FTSE 100 stock instead

This writer reckons there is a smarter way to invest in Nvidia today without taking on stock-specific risk. Here is…

Read more »

Young lady working from home office during coronavirus pandemic.
Top Stocks

5 stocks that Fools have been buying!

Our Foolish freelancers are putting their money where their mouths are and buying these stocks in recent weeks.

Read more »

Young Asian man drinking coffee at home and looking at his phone
Dividend Shares

These 3 FTSE 250 stocks offer me the highest dividend yields, but should I buy?

Jon Smith considers FTSE 250 shares with a very high yield, but questions whether the income is going to be…

Read more »

View of Tower Bridge in Autumn
Investing Articles

Is FTSE 100 takeover target DS Smith a great buy?

A mega-merger between FTSE 100 giants DS Smith and Mondi has the City abuzz. But is there any value in…

Read more »

Young Black man sat in front of laptop while wearing headphones
Investing Articles

The WPP share price dips as profits fall. Here’s why it could be a top dividend buy

I'm starting to think the WPP share price undervalues the stock, especially if the long-term dividend outlook comes good.

Read more »

Black father and two young daughters dancing at home
Investing Articles

A £3K investment buys me 632 shares in 2 stocks for a second income!

This Fool explains how a second income is possible through dividend-paying stocks and details two picks that could help her.

Read more »