Cheap stocks with rich potential

Bella Kidman

With Growth stocks and momentum largely driving markets over the past decade, it's easy to be swept up with the crowd and invest in the "next big thing".

However, it was Warren Buffett who argued that the stock market is an "exceptionally efficient mechanism for the transfer of wealth from the impatient to the patient" investor.

Herein lies the essence of Value investing, with patient investors side-stepping market consensus to see past short-term pain in the anticipation of substantial sustainable returns in the future.

And there are two stocks, in particular, that our fundies believe are worthy of your attention.

In the final instalment of this three-part collection, two value experts - Michael Goldberg from Collins St Asset Management and Justin Koonin from Allan Gray - each name a compellingly cheap ASX-listed stock with serious upside potential.

A crowd favourite at an attractive price

Justin Koonin, Allan Gray Australia Equity Fund

As contrarian investors, it’s important that we show restraint and patience. We are prepared to invest for the long term, while we wait for the market to recognise the value we’ve identified.
One stock we have liked for a while is G8 Education Limited (ASX:GEM), an operator of a little under 500 childcare centres across Australia.

It’s no secret that the childcare sector has been hit hard by COVID-19, with parents preferring (or being forced) to keep their children at home for much of the past eighteen months. Such was the level of distress within the industry that the federal government was forced to introduce a sweeping package of support for centres.

But the childcare industry was already under pressure. In the year or so before COVID-19, it became clear that the industry was beset by oversupply issues, mainly due to overzealous developers. Thanks to these multiple headwinds, it is no surprise that G8’s share price is now less than 20% of its peak value in 2014, which was a time of great optimism and growth for the sector.

Even at the depressed occupancy levels G8 saw in 2020 – around 69% – we think it should still make around $70m in operating profit. With essentially no debt, this places G8 on a multiple of about twelve times operating profit at the enterprise level.

This is not particularly expensive – but we think occupancy should be significantly better than this in the medium-term future as the country returns to some level of ‘normality’.

How long it will take to return to normality, or whether it will play out as expected, is anyone’s guess, but for the patient investor holding a long-term perspective, we think there is considerable upside potential from here.