I snapped up these cheap shares this week after a 42% fall

I’m always on the lookout for cheap shares I can add to my portfolio. By cheap, I don’t just mean cheap. Rather, I focus on value.

When buying shares, one buys a small share in a company. So, if the long-term value is likely to be higher than the current price, thus the cost of tying up the money over time, I would see the stock as cheap. In short, this is what is known as the discounted cash flow valuation model.

buy director

One of the stocks I already have in my portfolio is a well-known pub chain JD Wetherspoon (LSE: JDW). That performance has hardly been a reason to pop a celebratory pint lately. Just the opposite – Shares have lost 42% in value over the past year.

But I understand that the chairman of the company dipped into his own pocket earlier this month to buy more shares when they were trading at £4.57 each.

It’s not just pocket change that is used. Insiders bought 2.6 million shares, meaning they spent almost £12m. He now owns over 30m Spoons shares, so I imagine he feels pretty confident about its outlook.

Since then, the stock has gained 13% in the past few weeks. congratulations!

But is there more to come?

Shares are cheap

I think that’s why I bought more stocks this week.

Looking at the company’s valuation metrics, this may not seem like a cheap stock. Last year’s profit after tax was just £19m, meaning Wetherspoons trades at a price-to-earnings (P/E) ratio of 34. That’s hardly a scream. In addition, in the past few years, the company has suffered huge losses.

But remember, I define stocks that are cheap based on what I think is their future earnings potential. Clearly, Spoons has had a tough few years due to forced closures from the hospitality space, rising costs and tightening consumer budgets. The last two remain a clear risk. But the direction of travel has been positive. The company is profitable again and I think earnings can grow.

The current P/E ratio may seem high. But in 2019, the chain made £73m after tax. Its current market capitalization is only about nine times that amount.

I bought it

That’s why I see this as a cheap stock.

Over time, I believe Wetherspoons can overcome its current difficulties and return to making money on a grand scale. It has proven in the past that it can do it, it has an effective business model, deep experience and a customer proposition that can make it more popular in difficult economic times.

All of that adds up to a recipe for future success, in my view. I think today’s prices show a very pessimistic outlook for this successful business – and have put your money where your mouth is!