Buying recovery shares is a risky move for any investor to make. After all, assets do not generally fall in price without good reason. However, the potential returns from buying what may prove to be undervalued assets can be high.
As such, investors may be contemplating the purchase of Bitcoin after its 80% drop from its all-time high. However, stocks such as Premier Oil (LSE: PMO) may offer more compelling risk/reward ratios than the virtual currency. Alongside another declining stock which released a trading update on Tuesday, it could be worth buying for the long term.
Low valuation The company in question is aerospace and defence business Babcock (LSE: BAB). Its trading update showed that it has made sound operational and strategic progress of late, with it winning a number of new contracts recently. They include an expansion into the aerial emergency services market in North America, as well as a significant win in Australia.
The company’s underlying earnings guidance remains unchanged for the full year, while its underlying margin is expected to be ahead of the previous year. Its order book and pipeline stand at £32bn, which is £1bn ahead of their level from the end of the previous year.
Looking ahead, Babcock is forecast to post a rise in net profit of 2% in the current year, followed by further growth of 5% in the following year. This suggests that while it faces an uncertain outlook, its strategy is working well. Having fallen by 18% in the last year, its shares now trade on a price-to-earnings (P/E) ratio of 6.5. This suggests that they may offer good value for money, as well as recovery potential.
Improving performance Also offering improving turnaround prospects is Premier Oil. The company’s shares have been impacted by an uncertain period for the oil and gas industry, with the price of black gold changing rapidly over recent months. This, though, is likely to remain a feature of the industry over the medium term, with various geopolitical risks among OPEC members unlikely to disappear anytime soon.
Premier Oil’s strategy appears to be sound. The company is continuing to raise production, while at the same time maintaining a low cost base. This combination is leading to higher free cash flow, which is allowing it to repay debt at an accelerated pace. Ultimately, this could put the company in a stronger position to cope with the uncertain environment which the wider industry faces.
Since the stock has a price-to-earnings growth (PEG) ratio of 0.1, it could offer a favourable risk/reward ratio for the long term. Certainly, there may be further risk of declines ahead after a drop of almost 50% since October 2018. But with the company appearing to have sound fundamentals, it could be a better recovery opportunity than Bitcoin. The virtual currency is tough to value, and its lack of infrastructure could ultimately hold back its turnaround potential in the long run.
Peter Stephens owns shares of Babcock International Group (LON:BAB). The Motley Fool UK has no position in any of the shares mentioned. 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.
Motley Fool UK 2019