Viewers may enjoy what they see on ITV (LSE: ITV). The media company’s long-suffering shareholders may feel less happy. Over the past five years, ITV shares have halved. That means, if I buy them today and they get back to their old price, I would have doubled my money even before considering dividends. Here is why I think the shares might soar and have been buying.
Sum of the parts
At the moment, ITV shares trade on a price-to-earnings (P/E) ratio of just six. That seems very cheap to me. Admittedly, Glasgow-based rival STV trades on a slightly lower P/E ratio. So perhaps the City is pessimistic about the prospects for broadcasters and content producers as a sector.
However, I see significant value in ITV. The traditional business remains strongly profitable. Advertising revenue in the first nine months this year was only 2% lower than last year, and I expect the World Cup to boost sales this quarter.
Meanwhile, revenue in the first nine months at ITV Studios was 16% higher than last year. I expect it to keep growing. A proliferation of competitors like Netflix means there is a strong appetite for third-party production facilities.
I think the impressive growth of the company’s production arm is being overlooked by many investors. ITV is both a growth company and a profit machine. In the first half, revenues grew 9% compared to the same period last year, while earnings per share doubled.
The current P/E ratio does not reflect that, in my view. If the value is highlighted – for example by a potential bidder making an offer for the studios business – I think the price of ITV shares could soar.
Damned if you do
A concern investors have about companies with a large traditional television business, like ITV, is that their lunch may be eaten by the rise of digital formats and streaming.
ITV has tried to respond with its own streaming service ITVX, planned to launch next month. Investors have marked ITV share down heavily since this was announced. They apparently fear that it will cost lots without producing decent profits.
I think the company is in a corner here. Doing nothing about the growth of streaming could cause revenues to fall. But its proactive plan to launch ITVX has also not impressed investors. I think the approach should help the business grow its already sizeable digital footprint.
Once the service launches and we see some commercial results, if my confidence in the strategy turns out to be justified, I expect ITV shares could increase in value. There is a risk, though, that the new venture soaks up costs without producing worthwhile profits. That could lead to the shares falling further.
ITV shares offer a 6%+ dividend yield
The business expects to pay a 5p per share annual dividend this year. That implies a prospective dividend yield of 6.7%, well above the average for FTSE 250 firms like ITV.
That is attractive to me. It is also likely to be well-covered: the company earned more than 5p per share in its first half alone. From both a growth and income perspective, I see ITV shares as undervalued. I have been buying them for my portfolio. If I had spare cash to invest, I would buy more now.
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C Ruane has positions in ITV. The Motley Fool UK has recommended ITV. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.