Bargain British stocks with long-term potential

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As value investors, we believe that the average market participant overreacts to short-term news – often related to earnings – which often has little or no impact on the long-run intrinsic value of the underlying business. We have also historically found underpriced securities in sectors deemed “uninvestable”. Many investors are still scared of banks thanks to the 2008 crisis, or avoid airlines because of the industry’s poor long-term record. If large parts of the market are unwilling to look at a particular industry regardless of valuation, then we are more likely to find mispriced securities.

Bargain British stocks to invest in

Today the company generates two-thirds of its profits from corporate, commercial and institutional banking and one-third from consumer, private and business banking. Over 80% of profits are generated in Asia, and the remainder in Africa and the Middle East. The bank is now sensibly run and the results have followed.

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Return on equity last year was 10% and management’s goal is to reach 12% by 2026. The tier-1 capital ratio is now nearly 14%. The board is targeting net interest and other income growth of 5%-7% per annum, which they beat handily last year but would consider a healthy rate of longer-term growth. Despite all this progress, the stock trades at less than 0.7 times tangible book value.

International Airlines Group (LSE: IAG), the owner of British Airways, is one of the largest airline groups in the world and one of the “big three” European aviation operators. It operates in the passenger airlines, cargo and loyalty businesses; and it has a particularly strong foothold in the profitable transatlantic market. With its partner, American Airlines, IAG commands a 58% market share of traffic between Heathrow and the US.

Given the quality of the management team alongside the reinforced balance sheet, we view the company’s valuation as highly attractive. IAG has delivered impressive and growing profitability over the past decade, except in the Covid years. The shares trade on six times earnings and a free cash flow yield of over 10%. IAG has previously shown a willingness to return capital to shareholders, paying out 40% of today’s market value in dividends and buybacks in the five years to 2020. The company has just reinstated its dividend.

M&S is back in fashion

Marks & Spencer’s (LSE: MKS) fortunes have waxed and waned in the last two decades. They finally changed for the better in 2017 when Archie Norman was appointed chair. He had already turned around Asda. At M&S he replaced 50% of the senior management; remade the store portfolio, with brighter stores in better locations; and updated the clothing lines for modern and younger customers.

In food, the board kept the premium positioning but broadened the offering to suit a weekly shop. After years of neglect of the online arm, the board crafted a digital strategy that has made M&S one of the top online retailers in the UK. They took out about £300 million in annual operating costs at the same time.

These efforts started to bear fruit in 2023, when the group started taking market share in food, and clothing and profits exceeded forecasts. The stock has bounced from £1 to over £4 in two years but we think it is still undervalued relative to its long-run earnings potential.

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