The appeal of buying something that seems cheap can be hard to resist. Some value shares are like that – they offer a stake in a brilliant company at a knockdown price.
But others apparent bargains end up being value traps. The price is marked down because other investors are already discounting some future risks I may not fully appreciate.
Still, a lot of UK shares look cheap to me right now. Some at least may well be bargains. So ought I to act now and start buying up value shares?
Risks and rewards
To answer that question I use my normal investment approach. At the end of the day, value shares are still shares.
When investing, I seek to buy into great companies at attractive prices. If a share has been marked down sharply in price, that can sometimes be because it faces challenges.
For example, one of the value shares on my radar from time to time is McBride. Its strong position in manufacturing cleaning products for supermarkets could help it make large profits. The shares have soared 44% this year, but are still 80% cheaper than five years ago. Are they a bargain for my portfolio?
Although first-half revenues jumped 32% year on year, the company reported a £20m pre-tax loss. Net debt of £170m dwarfs McBride’s £50m market capitalisation.
While I think McBride has potential as a business, the risks of high debt and inflation playing havoc with profitability put me right off buying the shares. I think the value share has lots of potential room to grow in price. But the risks are too big for my tolerance.
Quality on sale
But are all value shares like that?
I do not think so.
For example, Topps Tiles (LSE: TPT) sells for pennies per share. But it is profitable. Its price-to-earnings ratio is just eight and the dividend yield of over 7% certainly looks attractive to me. The company announced last week that its first half saw record revenues of £130m. Topps’s balance sheet looks a lot healthier than McBride’s. Topps ended its most recent financial year with £16m in adjusted net cash.
The company has also been looking to the future, growing its online-only businesses such as Pro Tiler Tools. That could help it maintain impressive levels of revenue growth.
I do see risks. For example, an uncertain housing market could lead to lower demand for building products, hurting sales and profits. Then again, that could cut both ways. If existing home owners stay put rather than sell in a choppy market, they may decide to renovate their bathrooms and kitchens.
I like the Topps Tiles business and would consider buying this value share for my portfolio today, if I had spare money to invest.
Hunting for value shares
Concerns about the UK economy mean many share valuations look fairly cheap right now. That might not last forever, especially if investor confidence picks up. Amid such shares I think there are some genuine bargains for my portfolio.
So I am spending time right now hunting for value shares I can buy, while the going is good.
This post was originally published on Motley Fool
