I am always intrigued by stocks trading at dirt cheap valuations, as measured by their price/earnings ratio. A result of 15 is typically seen as fair value, so when something dips below 10 times earnings, that’s a pretty deep discount. Are the following two bargains a buying opportunity, or do the risks outweigh the potential rewards?
Car dealer Pendragon (LSE: PDG) trades at a forecast valuation of just eight times earnings after a tough time that has sent its share price crashing 40% over three years. It is down another 2.26% at time of writing after posting a 6.4% drop in group revenue in this morning’s interim management statement, or 7.2% on a like-for-like basis.
Down with a bump
Earnings from both used and new motor sales in the UK are falling, amid economic uncertainty and the demonisation of diesel, hitting Pendragon hard. The group has downgraded its annual profit guidance, blaming new global vehicle testing standards for disrupting supplies and hitting revenues.
There were some positives, with gross profit in the used car business jumping 20%, although new car profits fell 0.3% and after sales revenue was down 3.5%. Management reported signs of improved used car performance in the third quarter, and said this should be a key growth area next year.
The damage to the share price may have been even greater but Pendragon prepared investors by warning last week that profits were in peril as new vehicle tests knocked sales. Royston Wild still reckons it can be a dream stock for income seekers with the dividend up a bumper 300% in the last five years alone. The current forward yield is 5.4%, handsomely covered 2.2 times by earnings.
While City analysts predict earnings per share (EPS) will fall 6% this year they are pencilling in 16% growth for 2019. This could be one to park in your portfolio, especially if you think Brexit and car regulatory clouds will lift next year.
Factory of fun
Cards, gifts and party supplier Card Factory (LSE: CARD) has had an even worse time of it lately, falling 50% over three years. The discount retailer is also trading at a discount, with a current valuation of just 9.4 times earnings. The dividend is even juicier than Pendragon’s with a forecast yield of 8.3%, although cover looks thin at 1.2 times earnings.
As Roland Head points out here, Card Factory paid out £164m worth of dividends in 2017 and 2018, yet during that time it was generating annual free cash flow of just £125.8m, he calculates. That kind of mismatch cannot last forever.
Like so many retailers, Card Factory has been hit by consumer uncertainty. Last month, it posted a drop in underlying pre-tax profit and like-for-like sales, which it blamed on extreme weather and consumer caution.
Six-monthly revenues did climb 3.2% to £185.3m, helped by new store openings and growth in the online business, and pre-tax profit jumped 17.2% to £27.2m. However, underlying pre-tax profit fell 13.9% to £22.7m. Both revenues and EPS are forecast to climb in the year to January 31 2020, so this could be a good entry point although in this case, high income equals high risk.
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harveyj has no position in any of the shares mentioned. The Motley Fool UK owns shares of Card Factory. The Motley Fool UK has recommended Pendragon. 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.