Identifying undervalued UK stocks is a great way to optimise investment returns. It can require some upfront research. There might also be a need for a degree of patience being shown.
Even during periods of market upswings, there are opportunities to find and invest in undervalued shares. Several factors can result in a company being undervalued. The key is researching and identifying those factors and waiting for the right opportunity to invest.
| Company Name | Industry | Market Cap |
|---|---|---|
| Ceres Power | Alternative Energy | |
| Imperial Brands | Tobacco | |
| Standard Chartered | Financials | |
| Berkeley Group | Home Construction | |
| IAG | Airline |
What Makes a Stock Undervalued?
Any calculation of a stock’s value involves combining hard data with a degree of subjective input. That’s why even top analysts at big banks who value stocks for a living can come up with different views on whether a stock is a buy or a sell.
The data-led element of the approach largely considers earnings. Most classic valuation models start by considering a firm’s current earnings, as reported in the financial statement released to the investors every quarter.
This can be used to calculate the P/E ratio, which compares a company’s current share price to its current earnings.
Undervalued stocks may have a P/E ratio below the average, but that isn’t a requirement. It is more a case of investors taking a view on whether the share price now accurately reflects the future earnings potential of the firm. This brings in the subjective element of the process.
Ceres Power Holdings Plc (LON: CWR)
Ceres Power Holdings is in the interesting position of receiving positive press coverage but seeing its share price slump. As one publication put it, the “hydrogen hype bubble” needs time to reflate. The pullback in CWR could be treated as an opportunity for long-term investors to buy the dip.
The hydrogen fuel-cell manufacturer and green energy service provider is yet to turn profitable but has the potential to snap up market share in a growth sector. The company’s revenue growth between 2015 and 2020 was impressive, although it has since declined. However, profit margins are improving.
Investing in CWR should be considered a slow burn. The firm isn’t forecasting a net profit until 2027, but that is partly down to its commitment to invest all of its spare capital in a pipeline of green energy solutions. Given the potential of the hydrogen fuel sector, this could be a decision that pays off handsomely.
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Imperial Brands Plc (LON: IMB)
UK-headquartered Imperial Brands manufactures, imports, markets and sells tobacco and tobacco-related products in Europe, the Americas, Africa, Asia and Australasia. Founded in 1901, it has grown an extensive global client base.
Imperial Brands’ position as an undervalued stock stems from it falling out of favour with ethical investment protocols. This market is steadily growing, and retail and institutional investors are, as a result, shunning the tobacco sector.
This leaves room for investors to snap up shares in a company that has an established and well-run business model and a strong annual dividend yield. Those metrics look even more impressive when the company’s status as a recession-proof stock is factored in.
There aren’t any catalysts that are likely to make smoking more popular again, although the company does have a vape product. Even so, Imperial Brands is a company that just does what it is good at, and with a lot of bad news already priced in, it’s one of the best undervalued UK stocks to buy now.
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Standard Chartered Plc (LON: STAN)
London-listed Standard Chartered can be considered an undervalued stock for a variety of reasons. Its membership of the banking sector means that it benefits from elevated global interest rates. The exposure that the firm has to growth markets in Asia could also act as a catalyst for share price growth.
The firm provides banking products and services primarily in Asia, Africa, Europe, the Americas, and the Middle East and has a retail, commercial, and corporate client base.
Standard Chartered’s balance sheet can be expected to improve as base interest rates rise. This allows banks to increase the spread between the bid and offer rates applied to savers and borrowers. However, one headwind to be aware of is the company’s exposure to China’s real estate and banking sectors, which resulted in its pre-tax profit dropping by 33% in the third quarter of 2023.
Standard Chartered may be listed on the LSE and headquartered in London, but many see its real opportunities for growth stemming from its connections with Far East economies and its well-established global network of offices. The firm’s site states its commitment to exploit “Trade corridors of the future” that “will cut across continents.”
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Berkeley Group Holdings Plc (LON: BKG)
Berkeley Group Holdings Plc was particularly exposed to the headwinds faced by the financial markets in 2022. It’s a relatively small-cap stock ($4.25bn), which operates in the construction industry and has a track record of being a high-beta stock.
Having hit a high of over £55 per share in 2020, BKG stock then slumped to trade below £32 in 2022. The stock has gained since then, but the current level still provides a buy signal for anyone looking to pick up an undervalued UK stock that has a track record of successfully navigating such peaks and troughs.
The UK market that Berkeley operates in has a chronic, long-term shortage of housing stock. There remain many obstacles to developers hoping to build on greenfield sites, which makes the urban and brownfield sites that Berkeley specialises in developing a more feasible option.
At current share price levels, BKG is a good value stock with great prospects for future share price growth as the UK’s planning controls become less stringent.
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International Consolidated Airlines Group (LON: IAG)
IAG shares were significantly impacted by the pandemic, like the rest of the sector. However, despite the demand recovery and the company performing extremely well, its share price is still way off its pre-pandemic levels.
The macroeconomic climate and staffing issues not long after the travel restrictions were lifted have played a significant part in keeping the IAG share price subdued. The lack of staff, which hit many airlines, now seems to be behind the company, while the rate of inflation is easing significantly.
However, the rise in the cost of living has impacted consumers, and interest rates remaining elevated could mean consumer demand becomes a problem for airlines in the near term. In addition, it also means higher borrowing expenses for carriers. Geopolitical tensions, which resulted in rising fuel prices, remain a concern.
Even so, IAG has recently delivered some encouraging results, with travel demand remaining strong. IAG has also been working on reducing its debt pile. Given the current share price and its longer-term outlook, IAG is one to consider.
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Why Invest in Undervalued Shares?
One of the reasons to consider investing in undervalued stocks is the potential for high returns. Given their depressed share price, undervalued stocks have the potential to appreciate significantly if the market catches on to the fact the share price is undervalued, of course. Buying at low prices can lead to high returns for investors who hold these stocks for the long term.
In addition, when buying undervalued stocks, you hopefully provide your portfolio with a margin of safety. Buying an undervalued stock means you purchase the shares at what you perceive is a discount to its intrinsic value. This gives you a margin of safety in case the company’s performance does not meet expectations.
Finally, when investing in stocks that have underwhelmed, you invest in an asset that you believe has long-term potential, providing the potential to generate good returns for investors over the long term, even if they experience short-term volatility.
Investing in undervalued stocks presents opportunities for substantial potential returns if you can hold the position until ‘normality’ returns. Determining ‘normality’ involves a degree of subjectivity, but if you make the right call and can ride it out, then super-sized returns are possible.
What to Know Before Investing in Undervalued Stocks
Some stocks are ‘cheap’ because they deserve to be. However, even if your undervalued UK stock has all the potential catalysts in place for a future price surge, there can still be challenges along the way.
One factor to consider is opportunity cost. It can take time for the information that you used to pick your stock to feed through to the wider market. Until that happens, the capital tied up in your undervalued stock position can’t be used in other strategies.
Single-stock risk is also a concern. There aren’t products such as exchange-traded funds (ETFs) that identify ‘undervalued stocks.’ This means that you have to build your own portfolio and that there are fewer options to diversify risk across a basket of different positions.
You may consider a whole sector to be undervalued, in which case you could buy an ETF fund-style product. However, if you’re stock picking, risk management can come down to trading in small size and spreading capital across a number of stocks with the same characteristics. This does require a greater degree of work and ongoing risk management, though.
In terms of practicalities, it’s also worth mentioning that as undervalued stocks can be a long-term investment, it’s more cost-effective to buy the shares outright rather than trade them in CFD form. This is important to keep in mind as most good brokers offer both CFD and share dealing accounts.
This article expands on the best approach to take to make sure that you trade as efficiently as possible.
