Making money in the stock market isn’t about being popular, it’s about being right. When an entire sector falls out of favour with the wider market, it’s often worth searching for pockets of value.
In this article I’ll look at two very different companies which I believe have the potential to deliver market-beating returns.
A FTSE 100 bargain?
British Airways owner International Consolidated Airlines Group (LSE: IAG) reported a 28.8% rise in profit after tax last year. The group’s diluted earnings rose by 25.7% to €0.88 per share, putting the stock on a trailing P/E of just 7.1.
Much of this growth was the result of IAG’s continued expansion. Available seat kilometres (a measure of capacity) rose by 9.4% to 298,431m in 2016. Reassuringly, the group’s load factor — the proportion of seats sold — remained stable, rising by 0.2% to 81.6%.
One potential problem was that pressure on ticket prices and adverse currency movements caused reported passenger revenue to fall by 2%. This was offset to some extent by lower costs, but price competition from budget airlines remains a concern.
However, IAG’s finances remain in good shape, despite pressure on ticket prices. The group’s operating margin rose from 10.1% to 11% last year, while its adjusted net debt, which includes lease costs, edged lower, falling by 4.1% to €8,159m.
Broker consensus forecasts suggest that IAG’s profits will remain flat this year, at €0.88 per share. A dividend of €0.24 per share is expected. These forecasts put IAG stock on a forecast P/E of 7.1 with a prospective yield of 3.9%.
In my view, a fair amount of bad news is already priced into the stock. If trading remains robust, I think the shares could perform well from here.
A small-cap with big potential?
Gama Aviation (LSE: GMAA) specialises in providing private jet services for corporate and government customers. Previously known as Hangar 8, Gama has grown rapidly over the last five years through a mix of acquisitions and organic growth.
The group’s sales have risen from $26.9m in 2012 to $203m in 2016. Post-tax profit has risen from $0.49m in 2012 to $16.6m last year. With such rapid growth, you might expect Gama stock to be on a sky-high P/E rating already.
That’s not the case. Gama trades on a 2017 forecast P/E of just 8.3.
One reason for this is that the group’s expansion has partly been funded by issuing a significant number of new shares. Since April 2014, Gama’s share count has risen from 9.5m to 43.9m. This means that earnings per share have not risen as fast as the group’s headline profits.
I’d normally be wary about investing in companies where shareholder dilution is a serious risk. But Gama’s return on capital employed has averaged 16.9% over the last four years, suggesting to me that the group’s acquisitions are making a fair contribution to profits.
Gama’s adjusted earnings are expected to rise by 6% to $0.32 per share in 2017 and by 11% to $0.36 per share in 2018. These forecasts put the shares on a forecast P/E of 8.3, falling to a P/E of 7.5 next year.
I’d want to do further research, but Gama looks like a potential growth buy to me.