Right now the UK stock market is full of bargains that have the potential to produce fantastic returns for value-seeking investors who are willing to make the most of these opportunities.
Today I’m going to outline two stocks that I believe are deeply undervalued and have the potential to double investors’ money over the medium term.
Pendragon (LSE: PDG) is one of the largest car retailers in the UK. Unfortunately, this industry is currently suffering from falling demand as consumers have been putting off big-ticket purchases due to Brexit uncertainty.
This change in sentiment has put the brake on Pendragon’s earnings growth. Underlying profit before tax fell £12.6m to £47.8m last year as total revenue ticked lower by 2.4% (a 24.3% jump in costs didn’t help matters). The good news is, for 2018, underlying earnings per share came in slightly higher than expectations at 2.8p, compared to the City’s projection of 2.6p. Analysts are expecting a slight increase next year as some one-off costs are not repeated, and on this basis, the stock is trading at a forward P/E of just 9.
Even though the company is facing some headwinds today, I do not think it is unreasonable to say that, over the medium term, earnings will recover as consumer spending returns.
Indeed, according to figures published last year, the average age of cars on Britan’s roads is now at its highest level since the turn of the millennium. Drivers cannot put off purchasing a new vehicle forever, and when confidence returns, I expect Pendragon’s earnings to jump, possibly back to the high of 5p printed in 2015.
If the company can achieve this target in the near term, the stock could be worth as much as 50p assuming a multiple of 10 times earnings, that’s an increase of 100% from the current level. On top of this, the shares also offer a 5.3% dividend yield.
Lookers (LSE: LOOK) is another company that I think could see a dramatic recovery in earnings over the next few years.
Like Pendragon, the car retailer is currently seeing a drop-off in demand for new vehicles as consumers put off purchases. Adjusted pre-tax profit declined 1.6% in 2018 as turnover rose 3.9%. Looking at these figures, I am optimistic that if the company can grow sales in such a hostile environment, when growth returns in the new car market, earnings could surge.
Right now, shares in the company are dealing at just 7.5 times forward earnings which, in my opinion, looks cheap even though profits are falling. For some comparison, the rest of the UK market is trading at an average forward P/E of 12.2.
Historically, Lookers’ operating profit margin has been around 56% higher than it is today, which implies that when growth returns and the group’s economies of scale start to pay off, earnings per share could potentially rise to 20p per share or more, according to my calculations (based on the City’s 2019 earnings target of 13.6p). This implies a possible capital gain of more than 100% from current levels. On top of this potential, there’s also a dividend yield of 3.2% on offer for investors.
Rupert Hargreaves owns no share mentioned. 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.