Buying shares that have fallen heavily in a relatively short space of time can be risky. Investor sentiment is weak and could deteriorate further. There may also be challenges ahead for the business, which leads to a disappointing financial performance.
However, recovery shares can also offer high reward potential. Their valuations may factor in a worst-case scenario that provides a capital growth opportunity for long-term investors.
Having fallen significantly in the last year, do Santander (LSE: BNC) and Gama Aviation (LSE: GMAA) now offer favourable risk/reward ratios? I think they could.
Weak performance
Business aviation services company Gama Aviation released a profit warning on Monday, with its performance in the third quarter weaker than expected across its divisions. The company had previously guided towards substantial growth in the second half of the year. Now that it has better visibility for the coming months, though, it expects underlying operating profit to be around $3m lower than previous expectations.
As a result, its shares have declined by as much as 27% following the news. This means that in the last year they’re down by around 46%, which is clearly hugely disappointing for investors.
While lower-than-expected demand could continue over the near term, the operational performance of Gama Aviation seems to be sound. It’s expected to post earnings growth over the medium term, while a price-to-earnings (P/E) ratio of around 9 suggests that it may offer a wide margin of safety. As such, and while further volatility and share price declines cannot be ruled out, I believe the long-term investment potential of the business could be enticing for less risk-averse investors.
Global growth
Santander shares have also been falling in the last year. The global bank has become less popular among investors despite a relatively strong operational performance. Its shares are down 29% in the last 12 months, which indicates that investors are becoming increasingly concerned about some of its key markets.
Clearly, countries such as the UK and Brazil are experiencing significant political change at the present time. This could lead to uncertainty for the bank, while general fears about the prospects for the world economy could lead to a continued de-rating of its shares. For example, the prospects of a global trade war, and rising US interest rates, may peg back its financial performance to some degree.
However, with Santander having made improvements to its efficiency and business model, it seems to be in a strong position to generate future growth. It trades on a P/E ratio of around 9, while it has a dividend yield in excess of 5% from a payout which is covered 2.2 times by profit. And with the company’s bottom line due to rise over the next two years, its overall financial performance appears to be sound. As such, and while it may prove to be unpopular over the coming months, I think the stock could deliver a successful turnaround in the long run.