New investors often mistake a stock trading near its 52-week low as a value stock that’s available at a bargain price. But that may not always be the case. A stock’s value is the stock price relative to the company’s fundamentals. If a stock is trading at a lower price, but the company’s future growth prospects are bleak, it is a value trap not worth touching.
While it is true that higher returns come from higher risk. The risk should be taken on certain expectations. You should know when to exit or risk losing your invested amount. Let’s try to understand the bargain stocks you should avoid and the ones you should buy.
Two bargain stocks I won’t touch
Air Canada (TSX:AC) stock slumped 14% back to its pandemic level of below $20 after 2022 earnings. The stock might look like a bargain at the current level, but is there value? The airline saw its revenue return to 87% of its 2019 levels, which is a good sign. But the $24.7 billion debt it accumulated in the two years and a 235% jump in fuel cost more than offset the return of revenue.
The coming years could be challenging as the rebound of air travel demand is over, and airlines are now operating closer to the pre-pandemic capacity. There is little room for revenue growth. While the airline expects its adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) to double from $1.46 billion in 2022 to $2.5 billion in 2023, the airline could still be at a no-profit, no-loss scenario. Almost $2.5 billion in interest and depreciation could leave earnings per share closer to $0.
A 57 times forward price-to-earnings (P/E) ratio is too high for a capital-intensive stock. This ratio means you are paying 57 times the earnings per share for one share of Air Canada. The ratio would have made investing sense if Air Canada was a turnaround stock regaining lost market share. But that is not the case. The airline industry is saturated, and AC is already a leader in Canada. Unless the airline can reduce its expenses significantly, there is no significant growth opportunity. Hence, I would not touch this stock, even when it has dipped to its 2020 level.
Cineplex
Cineplex (TSX:CGX) stock also fell more than 12% after its fourth-quarter earnings showed a 10% dip in theatre attendance. Traditionally, the theatre was resilient to a recession as people resorted to entertainment in difficult times. But does that scenario still exist? Today, the over-the-top (OTT) platforms have disrupted the theatre industry and made it sensitive to inflation.
The pandemic fueled the OTT culture further. That explains why box office revenue only recovered 66% to the pre-pandemic level. Cineplex is a leader in a saturated market. It reported a $113,000 net income in 2022, driven by growth in Amusement parks and location-based entertainment. It is looking to grow theatre attendance by focusing on premium services, but the growth numbers might not be impressive.
Hence, I would avoid buying Cineplex. Instead, I would buy a stock with a more promising growth prospect.
One bargain TSX stock worth buying
The right place to look for value stocks is in a growing or resilient market. Utilities are in a resilient sector, and power is a growing sector, as the proliferation of electric vehicles (EVs) drives demand for green energy.
Algonquin Power & Utilities (TSX:AQN) gives you a mix of both. The stock fell 33% in November 2022, as an aggressive interest rate hike significantly increased the interest expense and impacted its earnings and guidance. The company reduced its debt-funded capital spending on power projects, as they were no longer feasible. It also cut dividends by 40% and is selling assets to repay debt.
AQN stock surged 14% after the company announced its balance sheet improvement plan. At a 13 times forward P/E ratio, the stock is trading cheaper than its peers, as the company expects its earnings per share to fall to $0.57 in 2023 from the $0.67 estimate in 2022. But its earnings could improve when the interest rate falls.
