Sector Screener: two dirt-cheap stocks to buy low and sell high

All stock market investors aim to buy shares at low prices and subsequently sell them at significantly higher prices. While in theory this strategy is extremely simple, putting it into practice can prove to be far more complex. After all, no stock price is ever low without good reason. Economic and industry-specific difficulties can prompt investors to avoid buying lowly priced shares. Weak market sentiment can also dissuade some investors from purchasing high-quality stocks that temporarily trade at low levels.

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A long-term opportunity

However, dirt-cheap stocks can deliver stunning long-term returns. And several media shares currently trade at depressed prices due in large part to the global economy’s weak near-term outlook. The world’s GDP growth rate is forecast to fall from 3.5% in 2022 to 3% this year, according to the International Monetary Fund (IMF), before declining to 2.9% in 2024. And while interest rate rises appear to be coming to an end, the US Federal Reserve has retained a relatively cautious stance regarding the prospect of interest rate cuts due to inflation remaining above its 2% target.

A downbeat near-term economic outlook negatively impacts media stocks to a greater extent than most companies because they are typically highly cyclical. This means they are greatly affected by the economy’s growth rate, with the services offered by media companies such as advertising, branding and communications, generally being classed as discretionary rather than essential spending. As a result, demand for them is subject to significant change depending on levels of corporate profitability and expectations regarding future earnings growth. A sluggish economy essentially means lower demand for such services and, in turn, weaker financial performance among media firms.

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While today’s ongoing economic and sector-related challenges may persist over the coming months, the long-term outlook for media stocks is highly upbeat. Despite its apparent caution, the Federal Reserve is nevertheless expected to begin reducing interest rates next year, possibly down to 3.9% from their current level of 5.25-5.5% by the end of 2025. This is likely to act as a substantial stimulus to the world economy’s performance, and could therefore raise demand for media companies’ services, with a similar trend set to take place in other developed economies.

Indeed, the IMF expects interest rates across the developed world to decline towards pre-pandemic levels over the long run, as productivity challenges and demographic changes require greater monetary policy stimulus to be implemented.

Surviving short-term difficulties

Of course, there is likely to be a time lag between interest rate cuts and stronger financial performance among media stocks. After all, the clients of media companies must begin to feel the benefits of any economic stimulus in terms of improved profits and cash flow, before they raise spending on advertising, branding and other discretionary services.

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In the meantime, media companies must ensure that they have the financial means to survive an extended period of weak demand for their services. Their balance sheets, for example, should contain only manageable levels of debt that can be comfortably serviced during a period of constrained profitability. They should also seek to reduce costs to further increase their chances of survival. This, though, must be balanced against a requirement to remain ready to capitalise on an eventual upturn in operating conditions for the wider sector.

Some investors are already beginning to look ahead to an improved operating environment for media stocks. Having declined by 7% in 2022, the sector has risen by 18.3% since the start of the year. This makes it the FTSE 350’s seventh best performing sector year-to-date. Despite this, several sector incumbents still trade at low prices, suggesting they offer wide margins of safety for new investors. As such, there are opportunities for investors to buy low and subsequently sell at much higher prices as the sector recovers from its present difficulties.

Source SharePad. Data as at 20 November 2023.

A wide margin of safety

Advertising and communications specialist WPP (LSE:WPP) currently trades on a prospective price/earnings (PE) ratio of just 7.8. Its shares have fallen by almost 14% since the start of the year and are down 37% since the start of 2022, thereby bucking the wider media sector’s rise over the same period.

Source SharePad. Data as at 20 November 2023.

Investor sentiment towards the company has weakened, partly because of downgrades to its financial outlook. While it previously expected to produce like-for-like sales growth of 1.5-3% in the current year, which itself represented a downgrade, this was reduced to 0.5-1% in its third-quarter results. In the same update, it also downgraded its forecast operating profit margin for the 2023 financial year from 15% to 14.8-15%, with cautious spending trends among its clients as a result of a weak global economic outlook being the main contributor.

Although WPP’s net debt increased by £0.4 billion to £3.9 billion in the third quarter, the company expects it to be unchanged year-on-year in its 2023 annual results. In its half-year results, net gearing amounted to 86%. While this is relatively high, and the company was only able to cover net interest costs 2.4 times in the first half of the current year due to weaker profitability, its financial position is sufficiently sound to enable it to overcome short-term industry weakness.

Encouragingly, the firm announced a simplification of its structure in its Q3 update that is expected to yield annual cost savings of at least £100 million by 2025. This is in addition to the £200 million in annualised cost savings that are set to be generated by a five-year efficiency plan announced in 2020.

With a broad geographic spread and a focus on new technology, WPP is well placed to capitalise on evolving global trends. Its low valuation, sufficiently sound financial position and the prospect of growing demand for its services mean it offers significant capital growth potential over the coming years.

A sound long-term growth strategy

Similarly, fellow media sector incumbent ITV (LSE:ITV) has an impressive long-term growth outlook. Its shares have fallen by 18.1% since the start of the year after posting a decline of 32% in the prior year. They now trade on a forecast PE ratio of only 7.7 due to a forecast decline in earnings per share caused by a tough operating environment.

The company’s recently released third-quarter trading update highlighted that demand for TV advertising is weak due to economic uncertainty. Although total revenue rose by just 1%, the company’s studios division, which creates content for other TV channels and platforms, posted 9% revenue growth. The firm’s digital revenue, meanwhile, grew by 23%. Since the business expects two-thirds of total revenue to be derived from its studios and digital operations by 2026, their strong growth rates bode well for the company’s long-term financial prospects.

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ITV confirmed in its Q3 update that it is on track to generate £15 million of cost savings in the current year as part of a £50 million target over the next three years. Net gearing stood at a relatively modest 41% at the time of its half-year results in June, while net interest payments were covered a healthy 3.5 times by operating profit, despite a decline in earnings. This suggests it has the financial means to survive short-term economic woes to deliver a stronger performance over the long run.

Although shares in ITV remain unpopular among investors, their low valuation means they offer scope for significant capital gains. An improving long-term global economic outlook is set to prompt a stronger operating environment that ultimately acts as a positive catalyst on shareholder returns.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.