One of the first mistakes many beginner investors make is ignoring quality value shares. Why? Because by nature they’re the kind of stocks that appear unattractive. Why are they so cheap? What’s wrong? Why aren’t investors buying?
These are all very relevant questions.
In some cases, there is something wrong. Not every cheap stock is a bargain — that’s what separates them from value shares.
So what is a value share? Great question.
A value share is any share that’s trading below what’s considered its intrinsic value. That’s important because intrinsic value isn’t always that easy to quantify. Identifying such shares can be a very powerful investing skill.
Unlike growth stocks, value stocks are typically assessed with a longer-term view. Think five to ten years, rather than one to two.
It may be easier to spot an obvious growth stock. The company is killing it, everybody loves the product, and the share price is soaring. Easy money? Maybe. But it can only go so high and the higher it already is, the fewer potential returns.
A £2 stock could arguably double or triple with little effort, particularly if it’s traded that high before. But a £600 stock trading at an all-time high? Can it go higher and if so, by how much? More importantly, how much lower could it fall?
Of course, this all depends on the company. A product or service in high demand could easily catapult a £600 stock past £1,000. Conversely, a weak business in a dying industry could send a £2 stock spiralling into obscurity.
With all that in mind, here are two value stocks with not only solid financials but also rock-bottom prices. I already own both shares as part of a portfolio that I regularly contribute to.
Diageo
As one of the largest alcoholic beverage distributors in the world, Diageo (LSE: DGE) is a company with great potential. Boasting top-selling brands like Smirnoff and Guinness, it’s well-positioned for long-term growth.
But at £25 a pop, it isn’t exactly cheap. Still, that’s 37% lower than its all-time high of over £40. With a strong competitive advantage and consistent cash flows, analysts estimate it to be trading below its fair value.
The falling price has been attributed to a weakening economy in Latin America that led to reduced sales of rum. But it’s not just that. Global alcohol consumption is in decline. Diageo must find new ways to appeal to a younger generation that drinks less — or it could face further losses.
JD Sports
Earlier this week, Bank of America reinstated its Buy rating for JD Sports (LSE: JD) with a price target of 165p. That’s around 70% higher than its current 97p price.
With earnings forecast to grow at 34.7% per year and cash flow estimates putting it at 52% below fair value, that target seems realistic. The stock is down 58% from its all-time high of 232p on 12 November 2021.
However, certain factors could derail its recovery. Sports fashion is competitive and punters are fickle. Financial constraints could lead consumers to pick lower-cost alternatives. Rising inflation led to losses in 2022 and 2023 and may resurface.
But with a forward price-to-earnings (P/E) ratio of 9.1, it looks significantly undervalued. Given its strong brand and market dominance, I’m with Bank of America on this one.
This post was originally published on Motley Fool
