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High inflation and rising interest rates have been weighing on stocks for some time. As a result, I think there are some great opportunities for value investors right now.
For now, you could buy a 10-year government bond with an annual yield of 3.5%. But there are a couple of UK stocks that I think offer even better returns, which makes it worth the added risk at current prices.
JD Wetherspoon
The first on my list is JD Wetherspoon (LSE:JDW). The stock doesn’t look particularly cheap: the 17p per share it generates equates to a 2.8% return and the share price is close to £6.
However, I believe the company’s future cash flows will be much higher than in 2022. The overall business generated £22m in free cash, but this was after spending £85bn on one-time investments .
While I expect JD Wetherspoon to continue to invest, I don’t expect costs on this scale every year. And without them, the company would have earned around 84 pence per share, a 14% return at current prices.
I don’t count on the business reducing capital investments to zero. I don’t think that’s likely or smart of management. But at today’s prices, I don’t think they have to.
With shares priced at £6, even 25p a year would equate to a 4% return. And I think that’s very possible for JD Wetherspoon in the future.
The company’s debt level presents a risk, but investors are beginning to appreciate the potential here and shares are up 30% since the start of the year. This is why I would look to buy the stock sooner rather than later.
Lloyds Banking Group
actions in Lloyds Banking Group (LSE: LLOY) I also find them good value for money. The stock has been caught in the general uncertainty around banking, but I think the share price looks attractive here.
When valuing bank stocks, the usual approach is to take the return on equity a company generates and compare it to the cost of that equity: the price-to-book (P/B) ratio. By this metric, Lloyds looks cheap.
The company recently forecast returns on tangible capital of between 13% and 16% in the future. And with stocks trading at 90% of the value of your tangible capital, the return on investment looks good.
In my opinion, there are two main risks facing the bank at this time. One is rising interest rates leading to loan delinquencies and the other is the possibility of tighter regulations following the recent banking turmoil.
The way I see it, however, the current stock price already values these two risks. Even if the company’s earnings per share were cut in half, the yield would still be above the 3.5% offered by the 10-year bond.
That’s why I think stocks look undervalued right now. It’s one I’m looking to add to my portfolio come the new ISA season.
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