Buying cheap shares can be an effective means of generating high returns in the stock market. Certainly, no share ever trades at a low ebb without reason, and the risks of buying bargain stocks may be higher than for other companies. However, in the long run, the potential rewards can outweigh the risks in some cases.
With that in mind, here are two shares which have experienced troubled recent pasts. Their valuations are exceptionally low and could suggest that there is capital growth potential on offer for the long run.
Reporting on Friday was supplier of industrial chains and related power transmission products Renold (LSE: RNO). The company’s performance since the start of October 2017 has been disappointing, with raw materials prices continuing to increase. While there has been some success in passing those costs on to customers, the realisation of these price increases has been slower than expected.
Alongside a weaker US dollar, this is putting pressure on the reported results from the company’s North American business units. As such, reported revenues are now expected to rise by 5% for the current financial year. Adjusted operating profit is due to be below previous expectations, and slightly below the reported adjusted operating profit for 2016 and 2017.
In response to its profit warning, Renold’s share price has fallen by over 15%. In the short run, a further decline in its valuation could be ahead. However, in the long run the stock appears to offer a wide margin of safety. For example, it trades on a price-to-earnings (P/E) ratio of around 8, which suggests that it could deliver improving performance. And while potentially volatile, the rewards on offer over the long run could be significant.
Return to form
Also trading on a low valuation at the present time is aerospace and defence company Cobham (LSE: COB). It has experienced a hugely challenging period which has seen profit warnings and declines in its bottom line. This has been at least partly due to difficulties in the global defence sector, with government spending reductions creating sizeable headwinds for industry operators.
Now though, Cobham seems to be on the cusp of improved financial performance. Its bottom line is due to return to growth next year after a five-year period where its earnings have moved 70% lower on a per share basis. The company’s earnings are expected to grow by 23% next year. This puts it on a price-to-earnings growth (PEG) ratio of just 0.8.
Clearly, there is no guarantee that the company will be able to deliver on its upbeat forecasts. However, with an improving industry outlook and the potential for rising profitability under a refreshed strategy, the prospects for the business seem to be sound. Therefore, it would be unsurprising for its share price to continue to move higher after its rise of 12% during the last month.
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Peter Stephens has no position in any shares mentioned. 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.