Value investing has been shown time and again to be one of the most lucrative strategies for investors to follow if they want to profit in the market. Buying out of favour companies at deeply discounted valuations is how some of the world’s most famous investors built their reputation and enormous fortunes, and you can try to replicate their success by following a similar strategy.
That being said, value investing isn’t easy, you have to be prepared to buy stocks that have fallen out of favour with the market and have an iron conviction that your analysis is correct, which isn’t easy. But the results speak for themselves.
Building up cash
One potential value investment is the Mission Marketing Group (LSE: TMMG). Mission is a marketing services company, but unlike many of the firm’s peers, the shares trade at a mid-single-digit earnings multiple of 5.5. Most other marketing services companies trade at a forward P/E in the low teens so straightaway it’s clear there’s value on offer here.
Over the past five years, management has nearly doubled pre-tax profit and earnings per share have risen from 4.9p in 2012 to 7.3p as predicted for this year. Next year analysts have pencilled in further earnings per share growth of 15% implying a 2018 P/E of 4.8. As well as the attractive valuation, shares in Mission support a dividend yield of 4.1%.
Management has hiked the per-share dividend payout by 65% during the past four years. The one downside about the business is Mission’s relatively weak balance sheet. At the end of 2016, the company reported net assets of £77m and intangible assets of £83m. Still, management knows how important cash generation is and has been concentrating on improving cash generation. The firm reported a free cash flow of £5.3m for 2016, around 90% of profit before tax. During the year the company paid down £3m of debt, so it’s clear progress is being made with regard to the strength of the balance sheet.
Shares in Connect Group (LSE: CNCT) also looked to be fundamentally undervalued. At the time of writing shares in the distribution company trade at a forward P/E of 6.8 and even though earnings per share are set to decline by 16% this year, this outrageously low multiple seems unwarranted.
Shares in Connect have traded at a low valuation for much of the past four years but today’s valuation looks weak even by historical standards. For the previous four years, shares in Connect have traded at an average P/E of eight, implying a share price of 132.8, 33% above current levels. On top of the low valuation, the shares also support a dividend yield of 8.7%. The payout is covered 1.6 times by earnings per share.
The recent sale of Connect’s Education & Care division for £64.4m will strengthen the company’s overall balance sheet and provide extra firepower for the business to reinvest in expansion, increase dividends to shareholders or pay down debt. At the end of February 2017, the company had net debt of £150m.
Rupert Hargreaves owns shares in Misson Marketing Group. 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.