No matter what the market conditions are, undervalued stocks hold an attraction, especially for value investors. The appeal of a good deal is really hard to resist for most investors. However, it’s crucial to evaluate value stocks not just for where they stand now but for what they will become in the next three to five years. Undervaluation can be a sign of worse times to come.
An equity firm
Alaris Equity (TSX: AD.UN) focuses on providing funding to strong businesses that are in financial trouble and do not wish to give up control in lieu of financial assistance. This makes it an ideal partner for a wide range of businesses, though it has strict criteria for choosing the businesses to partner with. And when these businesses thrive with Alaris’s assistance, the company gets to reap financial benefits.
The company passes on the bulk of its benefits to its shareholders as dividends, but that’s not its only strength or the only reason to consider this stock right now.
The company is quite attractively valued at a price to earnings of 5.5 and a price to book of 0.7, and thanks to its discount, it’s also offering dividends at a powerful 8.7% yield. If you buy now, you can lock in this amazing yield and wait for the positive market sentiment to push the stock upward and benefit from capital appreciation.
A mortgage company
Investors are usually wary of small-cap stocks offering relatively high yields because they feel like the dividends may not be sustainable. However, MCAN Mortgage (TSX: MKP) is a high-yield, small-cap stock that investors can buy with confidence. Not only does it have a solid history of dividend growth, but the payout ratio is usually quite healthy (60% right now).
This makes its 9.6% yield quite attractive, and adding to the attraction is its undervaluation, with a price to earnings of just 6.5. The stock is discounted but not abnormally so, and it has a history of modest growth in a healthy market. Its undervaluation, combined with the small discount, may also indicate upcoming growth, which can augment its dividend-based return potential.
A business services and industrial company
Brookfield Business (TSX: BBUC) is one of Brookfield’s newly formed subsidiaries. The company makes investments in a wide range of global businesses with the aim to generate around 15-20% yearly returns. The company has invested about $7 billion in the last five years, and its portfolio is led by six significant investments, including leaders in the lottery and automotive battery industries.
The stock joined the TSX in March 2022, so there hasn’t been enough time to evaluate its performance, but it has only lost about 27% (since inception) in a relatively troubled market, which may be counted as a win. It’s also quite attractively valued right now, and considering both the discount and valuation; it may be gearing up for a strong bullish phase. It pays dividends as well, but the yield is quite modest at 1.2%.
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Foolish takeaway
Not all three undervalued stocks may offer strong capital-appreciation potential (through recovery) in the near future. Some of them might turn the corner around next year, and others might stay low through 2024.
It’s not a problem for the first two (Alaris and MCAN) since their dividends are reason enough to hold them long-term, but if you are unsure about Brookfield Business’s growth potential, it may be wise to stay clear of this undervalued pick.
