Perhaps the most important aspect of successful long term investing is obtaining a margin of safety. In other words, buying shares at a price that’s below their intrinsic value. Not only could this mean reduced downside, since the market has already priced a difficult future into the company’s valuation, it could also equate to higher returns from an upward re-rating.
With that in mind, here are two shares that appear to be exceptionally cheap. They could also prove to be stellar income stocks in the long run.
Uncertain future
Reporting on Thursday was online trading specialist IG Group (LSE: IGG). It is in the midst of a challenging period, with changing regulations meaning its future profitability is difficult to gauge. It also experienced a somewhat quieter period in the third quarter of the year, which meant revenue per client declined by 15%.
However, with Brexit talks set to commence and Trump’s spending plans ready to take hold, the future for financial markets is unlikely to remain subdued. This would be good news for IG, since it tends to be more profitable during volatile periods for share prices. Furthermore, the risks from changing regulations are omnipresent for online trading companies. According to IG’s update, the latest potential changes to regulations have not had any impact on its financial performance to date.
Trading on a price-to-earnings (P/E) ratio of 10.8, IG Group appears to offer upside potential. Its dividend yield of 6.5% is among the highest in the FTSE 250, while dividend coverage of 1.4, whilst below the usual ‘comfort level’ of 2, indicates that modest dividend growth could be ahead. Therefore, despite the risks from regulatory change that it faces, now could be a prudent time to buy the stock for the long run.
Declining performance
UK-focused retailers such as Halfords (LSE: HFD) are facing their most difficult year since the credit crunch. Consumer confidence is relatively low and with higher inflation becoming a reality, spending on non-essential items could come under pressure. As a result of this, Halfords is forecast to record a fall in earnings of 9% this year and 2% the following year.
Clearly, this is a disappointing outlook, which may put many investors off buying the stock. The reality, though, is that there is a chance of downgrades, since the outcome of Brexit talks is highly uncertain. Therefore, volatility within the wider retail sector may remain high and share prices could fall.
Despite this, I think Halfords appears to be worth buying. It has a P/E ratio of just 11.8, which takes into account the forecast fall in its earnings. It also offers a dividend yield of 5%, and since dividend is covered 1.7 times by profit, it appears to be highly sustainable.
Of course, there’s no guarantee that Halfords will mount a quick turnaround. But in the long run, its sound business model and strong finances should mean that it delivers relatively high capital gains in future years.