Recovery shares can prove to be risky, but yet highly rewarding. In the short term, there’s scope for continued falls in their valuations, with troubled financial performance and weak investor sentiment likely to remain in play. But with wider margins of safety, there may also be high capital growth potential on offer.
With the Saga (LSE: SAGA) and Games Workshop (LSE: GAW) share prices having fallen significantly, due to uncertain outlooks, could they now offer turnaround potential? Or do their risks make them relatively unappealing investments for the long term?
Games Workshop released a trading update on Thursday, which sent its share price 10% lower. This takes its decline in the last three weeks to around 25%, with investors becoming increasingly uncertain about the prospects for the business. The company stated in its update that trading since the previous update in September has continued well. Sales are ahead of the same period a year ago, while profits are at a similar level to the comparable period.
The company, though, believes that there may be some uncertainties in the trading periods for the rest of the 2019 financial year. This is unsurprising, given that consumer confidence is weak and is expected to decline over the near term. Although the rate of inflation fell last month to 2.4%, from 2.7% in the previous month, consumers remain cautious about the outlook for the UK economy ahead of Brexit.
Following its share price fall, Games Workshop now trades on a forward price-to-earnings (P/E) ratio of around 20. This suggests that while it may be able to deliver improved performance from a business perspective, its investment outlook remains relatively unappealing.
In contrast, Saga’s shares now seem to offer a wide margin of safety. The over-50s travel and insurance specialist has recorded a decline in value of 32% in the last year, which has put it on a P/E ratio of around 11. This suggests that investors are anticipating further challenges for the business, with a fall in earnings of 5% forecast for the current year.
The company is facing an increasingly competitive marketplace. Although it has become more efficient in recent periods, its customer acquisition costs have risen. This has caused margins to come under pressure, and may stifle bottom-line growth over the medium term. For example, earnings growth of just 2% is forecast for the next financial year.
Despite a period of slower growth, Saga could deliver an impressive total return. It yields 7% from a dividend, which is covered 1.5 times by profit. And with a strong position in its key markets and an increasingly loyal customer base, it could offer recovery potential in the long run. While investor sentiment may remain weak in the near term, the business seems to have a favourable risk/reward ratio after its disappointing share price performance in recent months.
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Peter Stephens owns shares of Saga. 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.