With heavy falls in the UK stock market in 2020, many share prices are well below their peaks. That can mean great bargains for investors. It offers chances to pick up shares in a quality company cheaper than usual. When looking for cheap UK shares, though, I wouldn’t just look at the price. I’d focus on why they are cheap. A company’s shares may have fallen because its business has been permanently damaged in the past few months. That could make it a value trap.
Other shares have gone down with the wider market, but are promising recovery plays. I’ve used that approach to choose two UK shares I would buy as recovery plays.
Builder Galliford Try has a cash pile worth more than its shares
Shares in construction company Galliford Try (LSE: GFRD) have plummeted in 2020. That was largely due to a demerger at the start of the year. Even after that, though, the share price continued to fall significantly.
It reported a big cash pile of £197m at the end of June. The company’s total market capitalisation is little more than half of that, at £112m. That means that if the company was dissolved, it could pay out a lot more than today’s price for each share – in cash!
The company is set to put that money to good use instead. It is currently focused on infrastructure projects and residential building schemes. With the government keen to spend recovery funds on infrastructure projects and an ongoing boom in housing demand, Galliford Try looks like the sort of prime recovery play I’d choose among cheap UK shares. A positive indicator is its recent announcement that it expects to resume dividends early next year. Shares have already started to climb – but I think they have further gains to make as the business returns to normal.
Babcock – a defence share in the sick bay
Defence contractor Babcock (LSE: BAB) specialises in dull but important work, from building battleships to maintaining helicopters. Normally this would provide stable cash flow. But the company has had a challenging couple of years, writing down values in its oil and gas business. The shares have been battered down as a result. Suspending the juicy dividend further damaged City sentiment. Babcock remains a familiar name among cheap UK shares, but I don’t expect it to stay this cheap for long.
Despite its stumbles, I think Babcock’s underlying business is as unlikely to sink as the ships it builds. With deep relationships, heavy spending customers like the Ministry of Defence, and limited competition, the company has a stable, profitable business model. A new chief executive began in September and looks set to right the ship.
The recovery is not here yet but investor sentiment is improving – the shares are already up over 30% from their lows. I think they have a lot further left to rise. To me, the Babcock share price looks a bargain.
The recovery for these cheap UK shares is already beginning
Both Galliford Try and Babcock have had double-digit share price rises already this month. I think that reflects their attraction as recovery plays. I think the recovery is just starting for them, so I’d buy them both.
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Christopher Ruane has shares in Babcock. 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.