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Value stocks can be a great addition to a portfolio. In time, oversold companies should return to a fairer valuation, with profits captured as the share price appreciates. Within the index, there are plenty of FTSE 250 shares that could be considered undervalued. I asked ChatGPT what it thought was the best option, and I was surprised with the result.
Getting the details
To begin with, ChatGPT didn’t understand the question. It decided to pick the index’s lowest-priced stock. This is an error, as the actual share price doesn’t correlate to cheapness. A stock can be trading at 10p, but be overvalued. Therefore, I had to clarify with the chatbot what value actually meant. Not a great start!
Once it correctly understood my question, it decided to pick B&M European Value Retail (LSE:BME). As for the reasoning, it highlighted the low forward price-to-earnings ratio. The low ratio suggests the market doesn’t expect much growth, but if earnings stabilise or recover, the valuation could rise, driving share price gains.
Interestingly, it also flagged up the dividend potential. It believes that retailers that generate stable cash flows often pay dividends. Even if modest, the dividend yield has become more attractive when the valuation is lower. This is true in the case of B&M, with a high dividend yield of 7.82%.
The flipside
There are several reasons why I disagree with ChatGPT on this pick. It’s true that on the face of it, the price-to-earnings ratio is low. But using this metric alone can cause problems.
In this case, the B&M share price has fallen by 58% over the past year. During this period, it has posted repeated profit warnings and disappointing trading updates. In the latest half-year results posted in November, group adjusted EBITDA decreased by 30.2% versus the same period in the previous year. Net debt rose by 9.1%, with the CEO trying to calm investor nerves by saying “we are taking decisive actions to improve our retail execution and restore our financial performance.”
From my perspective, the valuation is low because it’s simply not performing well. In order to justify being called cheap, I have to be convinced that the valuation is low but that the outlook for the company is positive. Therefore, the future share price doesn’t reflect the current price. Yet for B&M, I think the current share price is fair! So on that basis, I don’t see it as being cheap.
As for the dividend yield, it’s indeed very high. But this is a result of the sharp share price fall. The actual dividend per share has been falling for the past few years. This doesn’t make it undervalued for an income pick. Rather, it looks unsustainable.
It’s rare that 100% disagree with ChatGPT, but in this case, I think it has missed the mark. I could be wrong, with income buyers snapping it up and earnings potentially stabilising this year, which could give people more confidence to buy. But I feel there are better stocks for investors to consider right now.
This story originally appeared on Motley Fool
