The UK economy grew in the final quarter of last year and avoided a recession. But business and investor sentiment remains fragile. That helps explain why some London-listed companies continue to trade on attractive valuations. Buying such cheap UK shares could help me build wealth over the long term — but I do not just focus on price. I am looking for deep value by investing in companies I think have great prospects.
Here are two I have bought and have no plans to sell.
JD Sports
One of the success stories of UK retail over the past couple of decades has been JD Sports (LSE: JD). Not only has it honed a highly successful business model in Britain, it has replicated it internationally and built a massive global business.
In fact, what other retailers see as threats, JD has seized as opportunities. It has expanded significantly online to sell to its digitally savvy customer base. But at the same time, JD has proven its worth as a classic physical retailer. Indeed, it plans to open several hundred new shops annually over the next five years.
Other plans include targeting double-digit percentage revenue growth and achieving operational cash generation of £1bn annually. That is not the same as earnings (in a company’s cash flow statement, operating cash flows can be eaten into or boosted by investment and financing cash flows).
But cash flows are important and I think the projection helps show why JD Sports shares strike me as good value right now. With a market capitalisation of £9bn at the moment, the company is trading on around nine times projected operating cash flows. I see that as cheap.
Risks and downside
What about the possible risks involved?
Rapid expansion could increase costs, hurting profitability. The company may also stumble with international expansion, as many UK retailers have done before it.
But I remain upbeat about the proven potential of JD Sports.
In the past decade, the shares have soared over 25 times. In other words, investing under £40 a decade ago, I could have bought shares now worth £1,000. Historical performance is not a guide to what happens next, but it underlines the impressive recent performance of the company.
British American Tobacco
Another of the UK shares I plan to hold for many years sells something far less healthy than sportswear. British American Tobacco (LSE: BATS) is heavily reliant on selling cigarettes. As demand for them declines, I expect sales to be hurt.
The company does have some flexibility to try to offset that by increasing its prices. The addictive nature of nicotine and a range of premium brands like Lucky Strike give the company pricing power.
What I think sometimes goes unappreciated, though, is just how big the company’s cigarette business still is. Last year it sold over 10bn cigarettes per week on average. The market is in decline, but I think it has a long way to run yet.
The manufacturer is also developing its non-cigarette business quickly. That ought to break even next year and could end up contributing significantly to its huge cash flow generation. The company raised its dividend yet again this year and now yields 7.8%. I plan to hold it in my portfolio of UK shares for many years to come.
