As an investor, I always try to guard against buying into a value trap. That can be difficult, because in many situations distinguishing what is actually a great bargain from what turns out to be a value trap relies on subjective judgements about how a business might adapt to a changing environment. That is exactly the situation with one FTSE 250 share I own.
I have been thinking about whether to hang on in the hope of price recovery – or dump the lot at a loss.
An innovator that’s been out-innovated
The share in question is advertising group WPP (LSE: WPP).
Going back decades, WPP was a trendsetter. By buying up storied advertising agencies and building economies of scale, it was able to make large profits.
But the advertising landscape has changed. Investors fear what that means for the FTSE 250 company, explaining the 73% slide in its share price over the past five years.
The key problem is that lots of what WPP used to offer its clients is no longer valued like it was. Clients can do it themselves for little money.
So WPP’s offering looks less compelling to customers than it once did. Revenues last year fell 8%.
WPP isn’t standing still
As an investment, WPP had been a disaster in recent years.
Not only has the share price slid, but the dividend was cut during the pandemic and again last year. In fact, last year’s dividend per share was just a quarter of what it had been back in 2017. That is painful for shareholders and helps explain why the share has been pushed down so much.
More positively, though, that means that the yield currently stands at 6%, well above the FTSE 250 average.
Plus it is not all doom and gloom. Last year’s results were terrible in my view, but even in that annus horribilis, at the operating level WPP still made a substantial profit and generated sizeable cash flows.
It has launched a strategic plan focused on stabilising the business this year, before returning to growth. By reorganising its business structure and expanding its own use of AI, WPP hopes to turn the threat posed by the technology into an opportunity.
Success on that front is far from guaranteed. But the company does have expertise and creativity its clients do not. I think it could well use AI to deliver that more cost effectively.
I think this is a risky bargain
The share price collapse in recent years underlines the fact that the risks here are high.
If AI eats the ad industry’s lunch, even WPP’s turnaround plan might not be enough to stop revenues and profits from declining further. Even from the current price, the share price could yet implode.
But I think the share price fall has been overdone.
eWPP’s enterprise value (its market capitalisation and adjusted net debt) is around £4.8bn. That is just four or so times last year’s adjusted operating cash flow pre working capital.
That looks cheap to me even if the company simply stabilises – but I think over the long term, profits could grow again.
If that happens, over the coming years I think the share price could soar from here. I plan to hold my shares.
