If you’ve got some fresh cash to invest in the stock market, it’s tempting to look for the biggest bargains of the day. Don’t get me wrong — I love a bargain. But sometimes shares are discounted for a good reason. Just because it looks cheap, doesn’t mean it won’t continue to fall.
I reckon British Airways owner International Consolidated Airlines Group (LSE: IAG) could be a good example. At face value, the IAG share price looks dirt cheap, with a forecast price/earnings ratio of 4.8 and a dividend yield of 6.2%.
In a statement today, the company warned the recent pilot strikes and other disruptions around Europe would knock €215m from operating profit this year, cutting last year’s figure of €3,485m by 6.2%.
Although disappointing, this isn’t surprising. I’d normally be willing to treat this as a one-off issue. But IAG faces other problems as well which suggest to me the stock should be handled with caution.
Too good to be true?
The stock market doesn’t usually price profitable FTSE 100 stocks at such low valuations. So why is IAG trading at this level? I think investors expect profits to fall as market conditions remain tough.
In its statement, IAG boss Willie Walsh warned capacity growth would be lower than expected this year as the firm battles with overcapacity on European short haul routes. There’s also the risk further strike action could rack up costs and cause passengers to switch their bookings to other airlines.
I’m also concerned about the wider economic outlook for the UK and Europe. A recession could cause demand for flights to fall and crush the airline’s profits. Although I see IAG as one of the better choices for airline investors, I think the outlook is uncertain. With profits now expected to fall this year, I’m going to continue avoiding this stock.
A FTSE dividend I’d buy instead
At times like this, cyclical stocks like airlines can be risky buys. To protect our cash, I think it makes sense to focus on defensive quality as well as value. One stock I think scores well in these areas is consumer goods giant Reckitt Benckiser (LSE: RB).
Shares in this global group don’t look cheap like IAG. But Reckitt has a number of advantages I think could make it a profitable addition to a long-term portfolio. First up is the group’s large portfolio of defensive brands. Names such as Dettol, Durex, Nurofen, Gaviscon and Strepsils are part of day-to-day life for millions of people. We don’t stop buying these products in a recession.
A second advantage is that this is a very profitable business. RB has an operating profit margin of about 25%, compared to 12% (and falling) for IAG. Although Reckitt’s forecast P/E ratio of 18 and 2.5% dividend yield may look expensive, my feeling is the shares are still reasonably priced given the group’s high profit margins.
New boss Laxman Narasimhan does face some challenges, but I feel the group’s large portfolio of health and hygiene products should provide reliable profits for years to come. This is a stock I’d buy today and tuck away for 10 years.
