With the stock market having experienced a period of weakness over recent months, it’s perhaps easier now to unearth cheap shares. After all, stock prices are generally lower, and this could mean there are wider margins of safety on offer.
That appears to be the case with Santander (LSE: BNC). The global banking stock has recorded a 28% decline in its share price in the last year, which suggests that investors are pricing in the impact of potential risks facing the business.
With an impressive growth outlook, it could generate high returns. That’s not the case with all stocks, though, as evidenced by what appears to be an overpriced smaller company which released an update on Monday.
The company in question is specialist filtration and environment technology business Porvair (LSE: PRV). It released results for the year to 30 November 2018, delivering record revenue of £128.8m, an 11% increase on the previous year. Profit before tax increased £0.3m to £12m, while adjusted basic earnings per share grew 11% to 22.9p.
The company also reports it has a healthy order book, while acquisitions such as Rohasys BV and Keystone Filter have been integrated and are performing well. Such acquisitions have expanded its capabilities in industrial and laboratory markets, and could positively impact on its financial outlook.
However, with Porvair expected to post a rise in earnings of 5% in the current year, its price-to-earnings (P/E) ratio of 22 suggests it’s significantly overpriced. That’s especially the case while a number of other shares trade on low valuations following the stock market pullback of recent months. As such, it seems to be a stock to avoid.
Margin of safety
With the world economy having an uncertain outlook, now could be a good time to consider the investment prospects of Santander. Certainly, after its poor share price performance over the last year, it may experience continued paper losses in the short run. Risks, such as a rising US interest rate, slowing China growth and the potential for a global trade war, could hurt its financial prospects to a significant degree. But its share price now seems to offer an equally significant margin of safety.
For example, Santander has a P/E ratio of around 7. This suggests that investors may have priced in challenges for the world economy that may not materialise over the medium term. Its dividend yield of 6.2% appears to be very affordable given its earnings forecasts, due to be covered 2.3 times by profit in the current year. And with its bottom line expected to rise by 9% this year, its strategy appears to be working well.
With the world economy forecast to grow by 3.5% in 2019, Santander’s shares could be a surprisingly sound recovery option. With a low valuation, income potential and a bright earnings outlook, the stock may be underrated by investors at the present time.
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Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK owns shares of Porvair. 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.