Down by 25%: Should You Avoid Algonquin Stock?

Avoiding a discounted stock with strong fundamentals is rarely a good idea but its a sound strategy when there is problem with the fundamentals themselves.

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Heavily discounted stocks are quite appealing, especially when the slump is triggered by the market. However, if the decline resulted from a fundamental weakness in the underlying business, the discount may be considered a warning sign, and investors may remain wary of the stock.

But just like a stock recovery, businesses can turn things around for the better, and improvements in the underlying business may restore investor confidence enough to trigger a solid recovery. From that perspective, there is hope for Algonquin Power & Utilities (TSX:AQN), which is currently trading at a 25% discount from its last year’s (12-month) valuation and a massive 63% discount from its five-year peak.

The case for buying

Despite its beaten-down state, there are several reasons to consider Algonquin, starting with the drastic steps it has taken to stabilize. This includes the controversial decision (at least from investors’ perspective) to cut its dividends, which lost a lot of market value and investor confidence.

It also sold part of its business and has suspended certain projects. This shows that the company’s management is not afraid of making tough decisions and following through.

Then there are its fundamental strengths, a solid portfolio of power generation assets and a decently sized customer base. The company is growing its solar power output as well as adding to its already extensive wind power portfolio.

Another reason to consider this stock right now is its impressive 7.45% yield. Even though it’s still not close to the pre-slashed dividend levels, the company has started growing its payouts again, and it’s highly unlikely that it will antagonize its investors by slashing the payouts again.

Buying it now to lock in the current yield before the stock enters a recovery-fueled bull market phase might be a smart thing to do.

The case for avoiding Algonquin stock

There are also reasons to be cautious about this stock. The financial uncertainty and debt that caused its decline have not fully dissipated yet. The payout ratio for dividends is way above healthy levels. The financials are struggling a bit, but it’s not too dangerous.

Another factor to consider is the saturation of the power-generation market. A company like Algonquin, which relies heavily on renewable output, is also vulnerable to the rise of new green technologies or a transitional green power source like nuclear gaining traction.

Another reason to avoid this stock is its consistently weak performance. It hasn’t managed to regain investor confidence as it should have, and until that happens, the chances of losing money with this stock might be slightly higher than generating a profit, that is, if you keep the dividends out of the equation.

Foolish takeaway

If you are looking into Algonquin for ESG (environmental, social, and governance) investing, it can be considered a great pick. It’s even a compelling pick for dividends. However, there is a lot of uncertainty around the stock that might make most investors wary, and if you are planning on buying it, make sure you have gathered all the necessary facts.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Adam Othman has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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