To make money from investing, you need to buy assets when their prices are low and sell them when their prices have risen. It sounds simple, but is never that easy in reality.
Stocks that have been heavily sold-off may be cheap for good reasons, and not all cheap stocks are good value. A company with low valuation multiples may be suffering from major problems, or it could be down to cyclical factors. In these situations, investors will most likely find that there is more downside to come. And, as such, these stocks are described as “value traps”.
But, sometimes, the market may undervalue individual stocks. Market participants may overreact to negative news and underestimate the intrinsic value of a particular stock. To distinguish whether a particular stock is a bargain or a value trap, we need to take a look at the company’s underlying fundamentals.
With that in mind, I shall take a look at these 3 stocks:
GSK
GlaxoSmithKline (LSE: GSK) hqw been lagging behind the rest of its sector for some time now. Shares in the company have continued to trend lower this year, falling 4% since January, which comes on top of a 14% decline in its share price in 2014.
GSK has been struggling to replace declining sales of Seretide and Advair, two of its bestselling blockbuster drugs, as pricing pressures and generic competition have been more intense than originally anticipated. What’s worse, sales of Advair will likely continue to decline with introduction of a generic alternative to the drug in the US.
However, analysts are still bullish with their longer term revenue forecasts. Growth in new pharmaceutical products — most notably, its promising HIV and vaccines business — is poised to offset sales declines, and should return the company to growth by 2017. The consensus analyst estimate for revenue growth over the next five years is 3.5%. Underlying EPS is projected to decline by 20% this year, to 75.9p, before rebounding 11% in the following year, to 84.3p.
Its shares trade with a forward P/E of 17.3 and yield 6.0%.
Burberry
A reversal in earnings growth is also the cause of the decline in Burberry‘s (LSE: BRBY) share price this year. The value of its shares has fallen 27% since the start of the year, with the company issuing a profit warning in November. The slowdown in China was largely to blame for slowing sales growth, but there could also be other structural factors at play.
Changing tastes could also be to blame, as some of its competitors have been faring better from the downturn. Unintended complexity from running multiple labels — Prorsum, London and Brit — have also added to the internal complexity of its processes and increased management costs. But management is addressing this, and intends to unify its products under a single Burberry label by 2016.
Moreover, its shares trade at historically low multiples on its forward earnings estimates. Burberry trades at just 16.3 times it expected 2015/6 earnings per share of 73.7p. Over the past five years, shares have traded at an average forward P/E of 20.3.
Stagecoach
Falling demand for travel to big cities, which has hurt Stagecoach‘s (LSE: SGC) “Megabus” long-distance coach service business, has been largely blamed on the recent Paris terrorist attacks. However, many analysts suspect falling revenues could actually be due to a combination of structural headwinds.
Lower fuel prices, weak metropolitan bus routes and increased competition also seem to be causing revenue trends to weaken, and these factors should be of greater concern to shareholders. This is because, these structural factors are long term, and management has few options to deal with them.
So, although its shares trade at just 12.2 times forward earnings per share of 29.3p and yield 3.2%, I’ll be staying out of shares in Stagecoach until revenue trends begin to stabilise.