Buying unloved stocks such as Capita (LSE: CPI) can be a risky but yet highly rewarding strategy. Usually, a stock is unloved by investors for a reason. For example, this could be because of difficult trading conditions which are negatively affecting its financial performance, or internal problems that are causing disappointing operational performance. Either way, the short run can be tough for such stocks and their investors, with paper losses relatively likely for the latter.
In the case of Capita, it faces an uncertain future. The company is attempting to deliver a successful turnaround after a challenging period. However, with a wide margin of safety, it could post surprisingly high total returns in the long run.
Recovery potential
The current performance of the business remains disappointing. Underlying revenue in the recent half year period declined by 3%, although like-for-like growth was 1%. A quiet market caused difficulties for the business, with major contract wins of £403m being well down on the £879m from the same period of the prior year.
However, the company’s recent half year results showed that it is making progress with its recovery strategy. For example, it has disposed of its Asset Services business for £888m and also sold its transactional specialist recruitment business. It is also seeking to reduce costs, with it expected to realise around £57m in savings by the end of 2018. And, with a new simplified market facing organisational structure, the company may be becoming more efficient.
Looking ahead, Capita is expected to turn its performance around. For example, in 2018 it is due to post a rise in its bottom line of 5%. While below the growth rate of the wider index, it would represent progress after what has been a challenging period. With the company’s shares trading on a price-to-earnings (P/E) ratio of just 11, they seem to offer excellent value for money.
While it may take time for the company’s turnaround strategy to take hold, a wide margin of safety suggests the stock could be worth buying for the long term.
Improving performance
Another unloved stock at the present time is Electrocomponents (LSE: ECM). It reported an upbeat performance in its trading update released on Tuesday. The service distributor recorded a rise in revenue growth of 13% in the first half of the year. All five of its regions continued to see double-digit underlying revenue growth. Furthermore, the company is also making good progress with its initiatives to stabilise gross margin and it now expects to see an improvement in gross margin in the first half of the year.
Electrocomponents is forecast to post a rise in its bottom line of 18% in the current year, followed by further growth of 12% next year. This puts it on a price-to-earnings growth (PEG) ratio of just 1.2, which suggests it has a wide margin of safety and may be worth buying.
