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I am always looking for cheap stocks that I can add to my portfolio. By cheap, I don’t mean simply those that have a low price. Rather, I’m focused on value.
By buying a stock, one is buying a small stake in a company. So if its long-term value is likely to be significantly higher than the price one pays today, taking into account the cost of tying up money over time, I would view that stock as cheap. In a nutshell, that’s what’s known as the discounted cash flow valuation model.
Purchase of directors
One of the stocks I already owned in my portfolio was a well-known chain of pubs. JD Wetherspoon (LSE: JDW). His performance has hardly been a reason to pour a celebratory pint of late. Quite the contrary: shares have lost 42% in value over the past year.
However, I did notice that the company chairman reached into his own pockets earlier this month to buy more shares when they were trading at £4.57 each.
It wasn’t just pocket change he used. The informant bought 2.6 million shares, which means he spent close to £12 million. He now owns over 30 million shares of Spoons, so I imagine he feels pretty confident about his prospects.
Since then, the shares have risen 13% in a matter of weeks. Health!
But could there be more to come?
cheap stocks
I think so, which is why I bought more shares myself this week.
Looking at the company’s valuation metrics, these may not look like cheap stocks. Profit after tax last year was just £19m, meaning Wetherspoons is trading at a price-earnings (P/E) ratio of 34. That hardly screams value. On top of that, in the previous two years, the company had made heavy losses.
Remember, however, that I define cheap stocks relative to what I believe to be their future earnings potential. Clearly, Spoons has had a rough few years due to forced closures of hospitality venues, skyrocketing costs, and tight consumer budgets. The last two remain clear risks. But the direction of the journey has been positive. The company is profitable again and I think earnings could grow.
The current P/E ratio may seem high. But in 2019, the chain made £73m after tax. The current market capitalization is only around nine times that amount.
I am buying
That’s why I see them as cheap stocks.
In time, I believe Wetherspoons can overcome the current difficulties and return to making money on a large scale. It has shown in the past that it can do that, has an effective business model, a wealth of experience and a customer proposition that could make it even more popular in tough economic times.
All of that adds up to a recipe for potential future success, in my opinion. I think today’s valuation suggests too pessimistic an outlook for this successful business, and I’ve been putting my money where my beer should be!
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