As recession looms here in the UK, it seems I have few places to hide as an investor. While many panic as news gets worse, I remind myself that time in the market beats timing the market. Therefore, I will continue to invest in good quality companies as their share prices become increasingly attractive. With this in mind, one FTSE 100 stock that has caught my eye recently is Centrica (LSE: CNA). This integrated energy company has been taking over competitors and streamlining its business. The stock has risen 18% year to date and should remain strong in the face of the current economic turmoil.

Boring is better

In times of market madness, the most boring stocks often outperform. Centrica has certainly proved that. The company is simple to understand – it supplies energy services to homes and businesses in the UK (mainly through British Gas) and Ireland (through Bord Gais Energy). This accounts for the majority of the company’s revenue.

On top of this, the company owns Hive, a technology solutions business that sells energy appliances such as electric vehicle charging ports. Centrica is also involved in renewable energy projects (solar farms). Both of these segments account for a smaller portion of total revenue.

Over the past year, there has been severe disruption in the energy supply industry. Several companies have filed for bankruptcy as oil and gas prices soar, squeezing their profit margins. Centrica’s ability to survive through this period shows its resilience, which should benefit the company in the medium term.

The company has benefitted from this market weakness, taking on the customers of bankrupt energy supplier People’s Energy and acquiring Nabuh in recent years. This has increased its market share in the UK. Centrica is also actively disposing of exploration assets to pay down debt and strengthen its balance sheet.

Cash is king

Analysts have predicted the company will remain cash flow positive over the next two years. It currently has a 12-month forward free cash flow yield of 14%. Valued at a five times price-to-earnings ratio, the company is at its lowest valuation ever — even cheaper than 2008, at the peak of the great financial crisis.

One significant risk to the business is the recent windfall taxes mentioned by many politicians, as this would reduce net profits for Centrica. However, with several companies filing for bankruptcy in the energy services industry, I believe a windfall tax would be counterproductive. Further bankruptcies could lead to monopoly status for the few survivors (Centrica is likely to be one of them), creating further price pressure as the survivors control the market.

Overall, Centrica operates in a staple industry, is gaining market share, and improving its balance sheet. It’s currently priced at a very low valuation, meaning any positive news is likely to boost the share price and is a great addition to my portfolio for the uncertainty that lies ahead.

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Peter McMullan owns shares in Centrica. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Edwin Starr’s song War rings true today more than ever when we see the devastation caused to the people of Ukraine. The war has created much turmoil in financial markets too via extended supply chain issues, commodities shortages, and further uncertainty. Defence stocks have been one of the few bright spots in the Footsie so far this year and such stocks should benefit from revised government defence budgets and any geopolitical uncertainty.

BAE is shining

BAE Systems (LSE: BA.) has enjoyed significant share price appreciation due to the uncertain geopolitical backdrop, and this could continue. So far, £104bn of defence spending increases have been announced by seven European countries. BAE is already benefiting from this, with contract wins from the German government. Military equipment such as fighter jets and naval ships made up about half of the group’s sales as of December 2021.

The company is attractive to me both as an income and growth investor. It currently has a 3.4% dividend yield and the continued development of its cyber intelligence units should boost higher margins.

The shares are more expensive than their longer-term average, currently at 15x forward price-to-earnings (against an average of 11x). But I think they could get more expensive as rising tensions between China and Taiwan could be reflected in the price of defence stocks such as this. Regardless of that, general commitment from governments to increase defence spending should benefit BAE and so the company has scope to grow into its valuation. This is a stock I may add to my portfolio soon.

Avon is underperforming

Another large defence player in the UK is Avon Protection. Unfortunately, I can’t be so optimistic about this stock. The shares have fallen 61% over the last 12 months. This downtrend doesn’t appear to be ending any time soon either. The company confirmed plans to wind down its body armour business in December after Avon products failed US Army tests. Alongside this, it was announced that its CEO will leave at the end of this year.

Streamlining operations may lead to a turnaround for the stock longer term, but there’s too much uncertainty today for me to invest. Also, the stock is too speculative for my liking, given the high valuation at 40x earnings.

Software is the new defence

Two other companies I’ve been monitoring are Chemring and Palantir. Chemring supplies the defence industry through its Sensors and Information (S&I), and Countermeasure and Energetics products. The company saw a 27% increase in underlying profit for its S&I business over the past six months and should benefit from the government defence spending mentioned above. Chemring’s steady profits and reasonable valuation mean this could be a quality stock to hold in my portfolio for years.

Meanwhile, a high-growth play in this area is Palantir, an AI data analytics company that makes a digital clone of a business, aiming to improve its efficiency and digital security. It has won several US Government defence contracts and is currently bidding for a £360m contract to control the UK’s NHS IT infrastructure. It seems it has what Warren Buffett would describe as a ‘moat’ around its business because once a company adds Palantir’s clone to its digital infrastructure, it becomes hard to change provider. This could be a great long-term purchase for my portfolio.

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Peter McMullan does not own shares in any of the companies mentioned. The Motley Fool UK has recommended Avon Protection. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

How financial crises are dealt with

During a financial crisis, once an economy enters a downturn, what typically happens is that the country’s central bank will reduce interest rates. This encourages the population to take on debt and spend more, and the economy recovers over the next few years.

As the economy recovers, the central bank can then raise interest rates again, in preparation for the next crisis. Then the cycle repeats. However, over recent years, central banks have not been able to raise interest rates to the same levels as before. As a result, we have experienced ever-lower interest rates.

Too much debt to handle

We are now in a debt trap, with global debt-to-GDP at 360%. As central banks raise interest rates, they increase the likelihood of causing a recession. This is because higher rates would hurt consumers, who will struggle to pay for other goods as their debt repayments rise.

However, because of the high inflation rates witnessed globally over the last year, central banks have no choice but to raise rates in order to reduce demand and tame inflation. This rise in rates is causing a collapse in the bond market and house prices already (due to higher mortgage rates), and stock markets are now following.

Perfect for precious metals

Generally, precious metals perform well when real rates are negative – this means when inflation is higher than interest rates, as is the case in western nations today. Since many of the issues involving inflation are on the supply side, central banks can do little to reduce it. The only option for central banks is to try and ‘thread the needle’ – that is, raise rates enough to limit demand, without tipping the economy into a recession. This will be extremely difficult to achieve.  

During times of stagflation (slower growth and higher inflation), physical assets typically perform best, which could be seen in the last bout of stagflation in the 1970s. Corn prices nearly tripled. Wheat prices quadrupled. Does this sound familiar today? Gold was priced at $36.56 per ounce in 1970 and by late 1979, was over $400 per ounce. Silver performed even better, rising from less than $2 in 1970 to more than $30 at the end of 1979.

The benefits of precious metals in my portfolio are twofold: (i) they protect against currency debasement (or inflation) and do especially well during financial repression or stagflation; and (ii) they provide diversification benefits, as their performance tends to be uncorrelated to many other asset classes and does well when uncertainty arises in financial markets.

Due to the current macroeconomic uncertainty, I believe that precious metals are a good way to diversify my portfolio. Therefore, I am buying WisdomTree Physical Gold and WisdomTree Physical Silver for my portfolio.

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Peter McMullan owns shares in WisdomTree Physical Silver. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Shares of Meta Platforms Inc. (NASDAQ: FB) have been on a roller coaster this year. The share price dropped significantly after the company’s fourth-quarter 2021 earnings release. It then rallied over 15% after the release of its most recent earnings.

The backbone of Meta’s business is advertising across its platforms. Revenue for Meta’s family of apps – Facebook, Instagram, and WhatsApp – came in at $115bn for the year ending December 2021. I believe the value of this side of its business is worth significantly more than the current market price indicates. That means the metaverse is included in the price for free.

Emerging growth

Meta’s presence in the developed markets has now matured and it’s not experiencing the growth it once did. The company’s shares have experienced recent weakness due to the falling number of daily active users (DAUs). However, Meta’s strategic partnerships with mobile carriers in developing markets have led to 66m new users during the second half of 2021. This will help to offset the slowing growth Meta is experiencing in developed markets.

Aside from Meta’s legacy social media networks, the company has begun to heavily invest in the metaverse through its Reality Labs division. The metaverse allows Meta to diversify revenue and tap into the next generation of the internet (Web 3.0). The number of crypto wallets today stands at an estimated 230m. Putting that into perspective, this equates to the number of internet users in 2000. This space has exploded in popularity over the past two years, and its growth should continue.

Cheap as chips

Today, the company is priced ridiculously cheap in my opinion. Meta trades at an eight times forward enterprise value-to-EBITDA (EV/EBITDA) multiple, the cheapest it has ever been. On average, since FB’s IPO, the market was willing to pay 16 times EBITDA for the company. I believe this is a fair multiple for the company if it succeeds in continuing to drive growth through emerging markets. Also, Meta’s return on invested capital (ROIC) averaged 20% since 2016. This suggests its high spending on Reality Labs should lead to higher growth at some point in the future.

What is there to worry about?

Facebook had been the stalwart of social media until 2020 when TikTok exploded onto the scene. Chief executive Mark Zuckerberg is a very shroud operator. On Meta’s recent earnings call, he blamed competition from TikTok being the reason for Meta’s weaker earnings (for Q4 2021). I believe he did this in an attempt to ease concerns of anti-trust regulators, which seems a very smart move. TikTok is very much a Gen Z platform and does not come close to Facebook in terms of network effects. Facebook has 2.9bn monthly active users, which should continue to grow globally as outlined above.

Betting on management

The success of this stock will depend on execution by management. Management’s ability to continue raising the number of DAUs for its family of apps through movement into emerging markets, as well as its ability to execute on Reality Labs, is paramount. The metaverse may be a few years away from becoming mainstream, but if it pays off, I could be handsomely rewarded for adding to my holdings in in Meta.

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Peter McMullan owns shares in Meta Platforms. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Central banks have spooked markets recently with their hawkish rhetoric. We’ve been told inflation is no longer transitory. The Bank of England is now hiking interest rates to soften demand and try to bring inflation down to its target of 2%.

Markets are forward discounting mechanisms and, needless to say, they haven’t enjoyed this more aggressive policy stance. The FTSE 350 has held strong compared to other markets, down 3% year-to-date. It’s even up over 3% in a year. However, the tech-heavy Nasdaq 100 is down 29% (and 14% over 12 months). So it’s officially in bear market territory.

Many highly speculative growth stocks have lost over half their value in recent months. What’s going on and what am I doing about it for my portfolio?

Why are my tech stocks falling?

It’s easy for an investor like me to get confused by recent price action in the technology sector, as I’d view such companies as ‘the future’. An example is renewable energy stocks. But generally, growth stocks love easy money and low interest rates, which is why they fell so heavily as central banks pivoted to that more hawkish stance.

Higher interest rates and inflation cause investors to discount a business’s future profits more heavily, therefore giving them a lower present value today. This means investors aren’t willing to pay sky-high valuations for companies such as Darktrace, which is loss-making. The Nasdaq 100’s performance so far in 2022 underlines this point further.

It has to get worse before it can get better

China’s Covid lockdowns are hurting supply chains further and this has led to heightened inflation figures coming out of the country recently. Although US inflation fell compared to last month’s reading, if we dig deeper, there’s rising inflation in the service sector. Inflation is likely to remain heightened, meaning the US Federal Reserve and other central banks will need to continue quantitative tightening and hiking interest rates. This is bad for growth stocks globally, especially as it’s becoming increasingly likely that the UK and Europe will enter a recession.

With such a challenging investment environment so far in 2022, there are a few things I’ve learned.

Learning Lessons

As the great investor Warren Buffett once said: “Price is what you pay, value is what you get.” Many of the speculative growth stocks that produced triple-digit gains in 2020-21 were unprofitable businesses and overvalued when they started to fall. Taking Shopify as an example, which has fallen 81% from its November 2021 high, it’s still valued at 410 times on a price-to-earnings (P/E) basis. This is a stock that could fall another 80% before it reaches a fair valuation, in my opinion. Valuation matters.

Another lesson I’ve learned from the recent sell-off is that it pays to be diversified and to rebalance when a sector runs too far ahead of itself (technology in 2021). Buying commodities, gold, and defensive stocks (big pharma and defence companies) has served me well in 2022 and offset the losses I experienced in growth stocks.

Overall, buying a diversified portfolio of attractively valued stocks has performed well for me no matter the environment, and this has never been more evident than today.

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Peter McMullan does not own shares in any company mentioned. The Motley Fool UK has recommended Shopify. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

2022 has been a rough year so far. Bonds and equities are falling in tandem, meaning a traditional 60/40 equity-bond portfolio is off to a bad start. Therefore, I have been investigating new ways to structure my Stocks and Shares ISA to survive any market environment, and I think I may have found an answer.

Inflation

Inflation usually arrives as we come out of an economic downturn. Demand picks up as consumers become more confident about their financial position. This causes prices to rise as people buy homes and spend on goods and services. This environment usually benefits commodities, which have historically performed well in times of heightened inflation or ‘reflation’, such as when the news of a vaccine broke in 2020.

For this environment, I would add 10% to a diversified trust such as BlackRock World Mining Trust, 5% to a commodity trading adviser like Mulvaney Global Markets Fund, and 5% to individual miners.

Dis-inflationary boom

In the second environment, inflation is slowing but demand is still strong. The consumer is spending and banks are lending, so money is flowing through the system smoothly. People are optimistic about the future. The end of 2020 would be a good example of this.

For this environment, I want to own equities. I would allocate 15% to a simple S&P 500 index fund. With the other 5%, I would add individual stocks at attractive valuations, in the hope of outperforming the index – often called a ‘core and satellite’ strategy.

I have decided to add a fifth segment into my equal weight portfolio called ‘momentum’. Some 86% of the time, markets are rising, so I believe having a larger weighting toward stocks will benefit a long-term investor like myself. This strategy buys the winners and hopes they continue to win. Such strategies today are dominated by companies like Amazon that have been proven to win, no matter what.

For this environment, I would add 20% to a low-cost ETF such as iShares World Momentum Factor UCITS for my ISA.

Stagflation

Arguably the worst environment is stagflation. This is when growth is slowing/low, and unemployment and inflation are high. This is difficult because central banks are stuck between raising rates to kill inflation and taming policy to reduce unemployment and improve growth.

In this environment, precious metals shine. I would add 12% to WisdomTree Physical Gold, 5% to WisdomTree Physical Silver for my ISA, and add 3% to Bitcoin. I hope this protects my money from currency devaluation over the long run.

Deflation

The final environment comes as times get tough. People spend less, banks aren’t willing to lend, and the economy slows. A recession is imminent/present, and growth is nowhere to be seen. 2008 is a good example.

In this environment, I want to invest in secure assets. I would allocate 5% to a capital preservation trust such as Ruffer Investment Co, which can actively manage my money. With the final 15%, I would allocate it across various duration bond ETFs, such as iShares TIPS ETF, iShares Treasury Bond 7-10yr ETF, and iShares 20yr+ Treasury Bond ETF (5% in each).

Nothing is guaranteed of course, and my solution comes with risks as well as potential rewards.

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Peter McMullan owns shares in Ruffer Investment Co, WisdomTree Physical Silver, and Bitcoin. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Since its all-time high of £12.50 in January 2014, Rolls-Royce’s (LSE: RR) shares have been on a downward spiral. It isn’t hard for me to understand why, as the company has made a net loss in four of the last six years. However, with asset sales and streamlining of its business, is Rolls-Royce set for a brighter future?

The company’s main revenue driver is its jet engines, sold to aviation companies globally. Therefore, it’s understandable that Rolls-Royce made a loss over the past two years due to the major Covid-related disruptions to the aerospace industry. Due to this, the company had to issue large amounts of debt and equity in order to fund operations and stay afloat. This has significantly diluted shareholders since 2020 and is part of the reason for the company’s poor performance of late.

What does the future hold?

However, there are two reasons to be optimistic about the future prospects of Rolls-Royce. Firstly, the company has recently begun its initial round of asset disposals, aiming to bring in £2bn in order to shore up its highly geared balance sheet. The company also plans to slash overheads and restructure the business, improving overall efficiency.

The second reason for positivity is its movement into the nuclear space. The company is building small modular reactors (SMEs), which use uranium to produce energy. These could be hugely important to the clean energy transition as they are very efficient and produce small amounts of waste. Also, as oil and gas prices remain high, governments around the world will be desperate to find any potential solution to the current energy crisis, potentially benefitting Rolls-Royce.

Risk assessment

However, there are several risks if I were to invest in the company. After eight years as CEO, Warren East is planning to step down at the end of 2022. This is a major disruption at a time when the management team is key to the turnaround of the business. There is already a risk of poor execution by the management team, which would lead to a continued downtrend in the company’s share price, and the added uncertainty of a new CEO makes this risk even greater.

Also, the shares are not cheap, at 57x last year’s earnings. Don’t get me wrong: if management can successfully deleverage the company’s book while growing earnings, the valuation multiple should normalise. If this were to come to fruition, there could be a huge pay off for investors, as positive free cash flow leads to a reduction in debt levels and a potential dividend payment. However, comparing the company to PayPal, which trades at a 29x price-to-earnings multiple with revenue estimated to grow at 17% per year into 2026, is betting on a major turnaround at Rolls-Royce even worth it? I guess only time will tell, but I remain on the side line for now.

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Peter McMullan has positions in PayPal Holdings. The Motley Fool UK has recommended PayPal Holdings. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Darktrace’s (LSE: DARK) listing on the London Stock Exchange came at a time when many investors had lots of cash. From a price of £3.30 on the day of listing, the share price rocketed to a high of £10, before making a round-trip back down to its IPO price. The shares currently sit 56% below their all-time high. With the predicted growth in the cybersecurity industry, this stock could be a star performer in the FTSE 100 in the future, so now could be an opportune time for me to get involved.

Darktrace “interrupts in-progress cyber-attacks in seconds, including ransomware, email phishing, and threats to cloud environments and critical infrastructure”, or in simple terms, it uses artificial intelligence (AI) to prevent cyber-attacks.

For those unfamiliar with AI, it’s best described as software that learns from itself, therefore becoming increasingly efficient over time. This means that once Darktrace’s AI software is installed in a company’s systems, it learns where the most at-risk areas are and works to improve digital security there.

The software does so by providing technological ‘roadblocks’. For example, before an employee receives a phishing (virus-filled) email, Darktrace’s AI would block this email from entering the employee’s inbox. Even if the email reaches the person’s inbox (and he or she opens the email), Darktrace’s AI software would then block the virus from entering the system, and so on. There are multiple layers of protection, so even if an attack wriggles its way through one roadblock, it cannot take the company’s entire system down.

With the rise of technology, especially following the Covid-19 pandemic, the threat of cyber-attacks has risen exponentially. This is something many businesses are now aware of and are actively trying to counteract. In addition to this, with the turmoil created geopolitically due to the Russia-Ukraine war, I can’t help but worry that wars could become more commonplace. Look no further than the cyber-attack on the US Colonial Pipeline for evidence of this. All of this benefits Darktrace.

Darktrace is continually increasing the number of cybersecurity products it can offer, which has led to a boom in the company’s total customer base, from 4,677 to 6,531 year-over-year (YoY) to March 2022. In turn, revenues have risen 52% YoY, all of which comes in the form of subscriptions, giving investors greater certainty over future revenues. This is something I look for in any investment.

The company is growing rapidly, and its management is another positive point, with its founder Poppy Gustafsson still running the business as CEO 16 years after establishing it. Studies have shown that founder-led businesses tend to outperform others, as they are more likely to innovate and generate more valuable patents. Darktrace currently has more than 90 patents, confirming this observation and providing a competitive advantage over its peers.

With the company’s price-to-earnings ratio estimated at 43x 2025’s numbers, it is still expensive, but if it can grow its bottom line at a faster pace as its product offerings increase, Darktrace’s ratios may come down — and at this point I will add it to my portfolio.

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Peter McMullan has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

In addition to this volatility, investors today may favour companies with revenues now rather than far into the future, due to rising inflation and interest rates. We have witnessed this in real-time with the NASDAQ 100 (a proxy for technology stocks) officially entering a bear market (20% decline or greater) since its peak in November 2021. This could benefit the three companies mentioned below, in my opinion.

The first stock I may add to my portfolio is Shell, which should continue to benefit from a high oil price, as well as the transition to cleaner energy. Oil companies are under pressure by investors to be prudent with capital expenditure on new oil exploration, meaning a sustained higher oil price is likely. Since the market crash in March 2020, the oil price has risen over 300% and, although oil companies did cut their dividends following the crash, I believe this unlikely to happen again due to the huge energy expenditure needed to fuel the renewable energy transition (since all machinery, transportation, etc, still needs oil).

Lockheed Martin (NYSE: LMT) is a defensive company in every sense of the word. It makes fighter jets and other military weapons, as well as other combat machinery. The company has assured revenues because the majority of its business comes from government contracts. This allows it to pay a 2.6% dividend as it generates considerable free cash flow from the sale of its military equipment. Alongside this, the company has also been able to invest its profits into space exploration, a rapidly growing niche. This gives investors the benefit of assured revenue alongside an exciting growth aspect to Lockheed’s business at a reasonable 16x forward price-to-earnings ratio. The company should also benefit from increased defence spending by governments due to the Russia-Ukraine war.

Finally, Regeneron Pharmaceuticals (NASDAQ: REGN) and Bristol Myers Squibb are both extremely cheap, diversified ‘big pharma’ companies with strong free cash flow. Both companies’ share prices have remained strong during the market sell-off this year as investors seek defence in assets with more assured revenue streams. Regeneron has been under-appreciated by the market because of patent expiry for its Eylea drug, used to treat retinal diseases. Once drug patents run out, general pharmaceutical companies can recreate these drugs for a fraction of the price, rendering them worthless to the company that created them. Some of these patents don’t expire until 2030 and the company has a huge pipeline of potential drugs that could bring further revenue in the future. Both companies have recent momentum behind their share prices, and I see them as long-term holdings in my own portfolio.

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Peter McMullan owns shares in Regeneron Pharmaceuticals, Bristol Myers Squibb and Lockheed Martin. The Motley Fool UK has recommended Lockheed Martin. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

There are now 1bn streaming subscribers around the world, boosted for obvious reasons since 2020. This is only the beginning, with the global video streaming market predicted to grow by 21% per year into 2028. With the improvements of WiFi in emerging countries and the rise of 5G, on-demand streaming and subscription services should continue its upward trend.

The business

Previously, Discovery had leased out content to its rivals to be aired on their platforms for a fee. However, under the company’s new business model, it is ending these contracts and pulling all its content onto one platform, Discovery+, a subscription streaming service much the same as Netflix, available on all platforms and devices. This is set to expand rapidly, with higher margins and more assured revenue. Paying subscribers have grown from 15m to 22m in its first 12 months of launch. This has only been rolled out in the US but will be rolled out globally in the near future, which should lead to booming subscription growth.

The merger

WarnerMedia is set to merge with Discovery this year, creating WarnerBros Discovery (WBD). This will create the largest content library in the world, with 200,000 hours of programmes and over 100 channels.

WarnerMedia owns HBO and Time Warner. HBO currently boasts 70m subscribers on its streaming platform; however, I believe the platform has been dreadfully underutilised by AT&T, hence the reason it’s selling WarnerMedia. Netflix is now taking on huge debt levels to produce content and continue growing subscribers. However, the merger of Discovery and WarnerMedia means a huge amount of content is already available to users, and therefore I believe under better management WBD will compete with Netflix and Disney+.

Too cheap

With strong projected free cash flow and earnings of the merged company, alongside synergies and debt levels expected to be lower than previously anticipated, I believe the market is under-pricing the streaming powerhouse this merger will create.

Discovery is trading almost as cheap as it was during the 2008 financial crisis, on a 12-month forward price-to-earnings (P/E) ratio of 8x. In comparison to this, Disney trades on a forward P/E of 28x, whereas Netflix is valued at 34x the same metric. Both companies exhibit poorer margins than DISCA, and the Discovery+ rollout has only just begun, never mind the merger.

The biggest risk to the investment case is if management cannot execute on its strategy. However, with the experienced management team led by David Zaslav, I believe this is unlikely, since Zaslav already has experience in mergers when Discovery acquired Scripps in 2018.

Should the merger complete, I believe this joint venture will become a powerhouse in the streaming space. With this business owning content such as the NBA, Game of Thrones, and Harry Potter, the brand awareness is massive. As the market wakes up to this opportunity, the share price should soar, providing a welcome boost to my portfolio!

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Peter McMullan owns shares in Discovery. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.