As an investor, I am a bargain hunter. That means I am always on the lookout for cheap shares. But that does not necessarily mean targeting shares that trade in pennies.
Instead, I see cheap shares as ones that I can buy for markedly less than the long-term value of the business concerned. Here are three places in which I hunt for such bargains.
Misunderstood businesses
Sometimes a business is not well understood and that can lead to surprising valuations. As an investor, that can present me with the chance to buy cheap shares.
Take my recent purchase of Victorian Plumbing as an example. The online retailer has seen its shares fall 70% in the past year, meaning it now has a market capitalisation of £174m. I think that dip reflects investor worries that a worsening economy could dent demand for bathroom fixtures and fittings. That is a risk — but does it justify the price fall?
Actually the company’s sales in the second half of its financial year grew by around 5%, compared to the same period last year. It said it remains highly cash generative. Impressively, it started the month with around £43m in net cash – equivalent to around a quarter of its market capitalisation.
Although Victorian Plumbing is priced for a business facing demand headwinds, it continues to grow and has a robust balance sheet.
Cheap shares and the economic cycle
Some industries are cyclical. In other words, demand peaks and prices are high. That leads to more supply which, in turn, pushes down prices. The more that happens, the further prices fall until the market bottoms out and the cycle starts again.
Cyclical industries can be a good place to hunt for cheap shares – depending on the stage in the cycle when buying. At the moment, for example, I expect metal prices to fall further in coming years so have no plans to add miners like Rio Tinto to my portfolio.
But once I think we are close to the bottom of the current metals pricing cycle, I will consider buying such shares.
Fading industries
Some industries fall out of fashion with investors who perceive that their best years are behind them. But an industry seemingly in its sunset years can still be massively lucrative for decades.
Take tobacco as an example. In many developed markets, the percentage of people who smoke cigarettes has been in steady decline for decades already. Despite that, the market remains large and highly profitable. Last year, for example, British American Tobacco generated revenues of over £25bn and post-tax profit of close to £7bn. That underlines the very attractive profit margin enjoyed by many tobacco manufacturers.
Yet BAT shares trade on a price-to-earnings ratio of just 10. That makes them look cheap to me and indeed I hold them in my portfolio. While cigarette sales may be in decline, they remain high and the company is also utilising its global sales network to increase non-cigarette sales.