UK Edition
A haze of negativity currently hangs over the stock market. Investors are deeply concerned about the impact of rampant inflation, rapidly rising interest rates, impending tax rises and catastrophically weak consumer confidence on corporate profitability.
This is not the first time such a situation has arisen. Certainly, extreme levels of inflation and rapid interest rate rises have not been seen for many years. But deep-seated feelings of fear and negativity among investors are nothing new. In fact, they have occurred with surprising regularity, only to dissipate as the economy’s prospects gradually improve.
For long-term investors who can look beyond short-term risks, widespread stock market fear brings countless opportunities to buy excellent companies at a fraction of their intrinsic value. Bold investors, for example, can currently buy stocks such as the FTSE 250’s IMI at a discount of 27pc to the market value at which it started the year.
The specialist engineering company designs and manufactures products that control the precise movement of fluids. It operates across a wide range of industries and regions and has excellent long-term growth potential as environmental, demographic and technological change presents new areas of high demand for its products.
For example, its valve technology is used in fertiliser spraying systems to improve crop yields in an era of rapid population growth. Similarly, its valves are used to reduce vehicle emissions as increasingly stringent environmental regulations take effect. It is also investing heavily in providing solutions to challenges experienced in hydrogen storage and pipeline transport that offer attractive growth prospects as the world transitions to cleaner forms of energy.
The company’s move into new and adjacent markets reduces its reliance on the oil and gas industry, which has historically been one of its key markets. Its progress in operating across a more diverse range of sectors has been aided by acquisitions.
It has made several purchases over recent years, such as the recent acquisition of CorSolutions, a life sciences analytical instrument specialist, for $10m. Its solid financial position offers scope for further purchases.
IMI’s net gearing ratio of 80pc suggests that its balance sheet is not overly leveraged in an era of rapid interest rate rises. Meanwhile, net interest cover of more than 36 in its most recent full year shows it can accommodate significant further debt and/or interest rate rises without coming under financial pressure.
Its recent half-year results showed that its restructuring programme was aiding margin improvement. Its operating margin increased by 0.7 percentage points year-on-year to 16.4pc. The company remains confident of achieving a figure of 20pc over the medium term, which is likely to impress investors; most companies offer little scope for margin improvement in the current environment.
Indeed, margin improvement highlights the excellent competitive position of the company. This is likely to be a major advantage over the coming years as its pricing power enables it to overcome a period of persistently high inflation. Further details on its progress in this and other areas are expected in a trading statement on Tuesday.
For the full year, IMI expects to deliver more than 100p in earnings per share. The shares trade at around 13 times this figure.
In Questor’s view, this significantly undervalues the company’s long-term profit growth potential as it expands margins, engages in further mergers and acquisitions activity and capitalises on new growth areas as the global economy evolves. It also fully factors in the prospect of slowing global economic growth over the short term.
Since this column first recommended the stock in March 2019 it has generated a 28pc capital gain and outperformed the FTSE 100 by 26.6 percentage points. Investors who are bold and buy IMI after its recent share price slump are very likely to see an attractive return in the coming years.
Questor says: buy
Ticker: IMI
Share price at close: £12.90
Read the latest Questor column on telegraph.co.uk every Sunday, Tuesday, Wednesday, Thursday and Friday from 6am.
Read Questor’s rules of investment before you follow our tips