While no stock is perfect, some may hold more appeal than others. That’s because their potential rewards may substantially outweigh their risks and the resulting margin of safety could lead to stunning share price gains in the long run. As such, it could be worth backing stocks of this kind to a greater extent than some of their index peers.
For example, British American Tobacco (LSE: BATS) is facing a world full of increased regulation surrounding the use of tobacco. This is a given to an extent in developed markets, but the emerging world is likely to gradually ban smoking in places of work and restrict tobacco advertising.
While this is a concern for British American Tobacco, its move into e-cigarettes has the potential to deliver excellent profit growth in the long run. And with the absolute number of smokers across the globe on the up due to population growth, British American Tobacco seems to be well-placed to record continued bottom line growth in the long run.
With British American Tobacco’s dividend yield currently standing at 3.9%, it may not appear to be a superb income stock at first glance. However, with its earnings likely to rise at a high and consistent rate, it looks set to deliver rapid growth in shareholder payouts to boost its dividend potential over the coming years.
Rewards despite the risks
Similarly, GKN (LSE: GKN) may appear to be a somewhat risky stock. After all, the automotive sector is highly cyclical and if Chinese growth disappoints over the medium-to-long term, sales of motor vehicles could fall and impact on suppliers such as GKN.
While this is a real risk for the company’s investors, GKN offers a relatively wide margin of safety and therefore seems to be worthy of purchase. For example, it trades on a price-to-earnings (P/E) ratio of 9.9 and with its bottom line due to rise by 8% next year, it equates to a price-to-earnings-growth (PEG) ratio of only 1.2. This indicates that GKN’s share price could begin to reverse the 21% decline that has been recorded in the last year and could prove to be a very profitable long-term buy.
Bumpy road ahead
Meanwhile, Centrica’s (LSE: CNA) risks may appear to massively outweigh its potential rewards – especially after its shares fell by 10% yesterday following the announcement of a fund raising of £770m. The money will be used to pay down debt and to fund acquisitions as Centrica seeks to transition away from being a part-oil and gas specialist and towards a pureplay domestic energy supplier.
Certainly, it will be a long road to recovery for the company and there will inevitably be a number of lumps and bumps along the way. However, Centrica remains a high quality business that trades on a P/E ratio of just 13.7 and with a sound strategy and turnaround potential, it seems to be worth buying for the long term.