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Saga’s share price is rising. Should I buy the stock now?

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One UK stock that’s doing well right now is Saga (LSE: SAGA). Since the start of November, Saga’s share price has jumped about 180%. Meanwhile, over the last 12 months, it’s up 76%.

Is this a stock I should buy? Let’s take a look at the investment case.

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Saga: green shoots? 

When I last covered Saga, in October, the company was struggling. It had just posted a 70% drop in underlying profit before tax for the six-month period to 31 July 2020 and also raised money to bolster its financial position.

Since then, Saga has continued to struggle. However, there are signs that it could be turning things around slowly.

In the company’s recent full-year results for the period ended 31 January, for example, it advised that after several years of a decline in policy count, Saga-branded motor and home policies increased by 1.1% in the year. This was achieved by improving customer retention and generating a greater proportion of direct sales (relying less on price-comparison websites).

Meanwhile, underlying profit before tax in the company’s insurance division – which is where the group makes most of its money – rose 2.9% to £134.6m. This is encouraging. However, it’s worth pointing out that total group underlying profit before tax was down 84% to £17.1m due to big losses elsewhere in the business.

Turning to the travel side of the business, the company said that despite the travel business being suspended, customer demand has remained strong. For 2021/22 and 2022/23, it has £154m of total cruise bookings. That compares to £128m at the same point last year. This is also encouraging. However, the company doesn’t plan to recommence cruises until later this year.

Can Saga’s share price keep rising?

Looking at Saga’s valuation, I think the share price run may have further to go. Currently, analysts expect earnings per share of 57.5p for the year ending 31 January 2023 (next financial year). That equates to a forward-looking price-earnings (P/E) ratio of just 6.7. That seems low. It’s worth noting that analysts at Credit Suisse just raised their price target to 486p from 397p.

Should I buy Saga shares?

While the outlook for Saga appears to be improving, I won’t be buying shares for my own portfolio.

One reason is that in the past, Saga has not been very profitable. Between FY2016 and FY2018 (before it began experiencing problems), for example, its return on capital employed (a key measure of profitability) averaged just 6.8%. That’s low. That kind of return on capital isn’t going to give the company much money to reinvest for future growth, which means long-term returns from the stock are not likely to be high.

As Warren Buffett’s business partner Charlie Munger says: “Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six percent return – even if you originally buy it at a huge discount.”

Secondly, debt remains quite high. At 31 January, the company had long-term debt of around £820m on its balance sheet versus equity of £681m. This adds risk to the investment case, particularly given the uncertainty in relation to the travel division.

I think there are other stocks that are a better fit for my portfolio right now.

Like this one...

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Edward Sheldon has no position in any shares mentioned. 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.

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