2 top value stocks I’d buy in 2018

Twenty pound note

As domestic and international equity markets race ahead to ever loftier heights, value investors are likely finding it increasingly difficult to suss out attractively under-valued business that other investors are wrongly ignoring.

Thankfully, there are still a few stocks on the LSE that appear to me to be trading at prices well below what they should be. One is domestic retail bank Virgin Money (LSE: VM), which trades at just 0.81 times its tangible book value, far below the sector average of 1.17.

The main cause of investor unease towards the challenger bank is the growing worry that domestic economic growth is looking dangerously close to petering out. For a purely domestic retail bank such as Virgin Money, it’s easy to understand why this would be a problem.

Yet with the economy still defying negative prognostications I believe Virgin Money appears quite attractively priced for what is a fast growing, low-cost, highly profitable lender. In the first nine months of 2017 the bank grew its mortgage lending balances by 10% year-on-year to £32.9bn while taking its market share of gross mortgage lending to 3.5% during the period.

At the same time, it is also gaining market share in the credit card sector and attracting more customer deposits. Together with an operational structure that is much leaner than larger rivals, increased lending is leading directly to improved profit metrics. In the first half of 2017 the bank’s return on tangible equity increased from 12.2% to 13.3% and underlying pre-tax profits leapt to £128.6m.

With a stable capital position, these growing profits are sufficient to both invest back in growing the business and rewarding shareholders through a rising dividend that analysts expect to reach 5.725p for the full year. While this only represents a 2% yield at today’s share price, there’s still plenty of runway for management to continue boosting returns, especially as interest rates rise and increase lenders’ profitability.

An opportunity in others’ misery

While Virgin Money continues to power on, slowing consumer confidence in the housing market means profits are being knocked at replacement window and door manufacturer Safestyle UK (LSE: SFE). Over the past half year, the company has had to issue two profit warnings as consumer demand has begun shrinking, leading analysts to predict full-year earnings per share of 14.39p for 2017, against 20.33p for the year prior.

However, even with this lower level of earnings, Safestyle still trades at just 11.6 times earnings while kicking off a whopping 6.7% dividend yield that should be safe as its mounds of cash can cover outsize dividend payouts for some time. This looks to me an attractive price point for the business as it continues to grow and can actually use this market-wide downturn to its advantage by taking its cash-rich balance sheet and lower-cost-of-production facilities to accelerate market share consolidation in its very fragmented market.

Indeed, since the beginning of the last recession in 2007, the firm has more than doubled its market share from 4.4% to 11.2%. This process should continue as Safestyle expands into the wealthier southeast of England and pushes out weaker players thanks to its financial heft.

Investing in Safestyle now may not be for the faint of heart, but long-term investors could find this a tempting time to begin a position in a highly profitable, fast-growing market leader.

If investing in a company with falling earnings isn’t for you, I recommend checking out the Motley Fool’s free report on one Top Small Cap that has no such problem and is sure to attract value investors with its shares trading at just seven times earnings.

This rock-bottom valuation doesn’t mean low growth though as the company has increased earnings by double-digits four years in a row. To discover this under-the-radar growth and value option for yourself, simply follow this link to read your free, no obligation copy of the report. 

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Ian Pierce has no position in any of the shares mentioned. The Motley Fool UK has recommended Safestyle UK. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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