These 2 stocks are undeniably cheap

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Debenhams storefront

Today I'm looking at  two companies that I think offer exceptionally good value for money. They both trade on ultra-low valuations and while they have a difficult near term outlook, they also have the potential to turn their performance around to post improved profitability. Certainly, the near term may be volatile and uncertain for both stocks, but for long term investors they offer low prices and high profit potential.

A sound income stock

First up is Debenhams(LSE: DEB), which faces an uncertain outlook due in part to Brexit. Even though the government has not yet started the process of the UK leaving the EU, the effects of the referendum are being felt by UK retailers. The pound has weakened and this has caused inflation to creep upwards, since imported goods are now more expensive than they previously were. This has the potential to cause wage growth to turn negative in real terms, which could put pressure on disposable incomes and reduce consumer spending.

Debenhams is due to report a fall in its bottom line of 12% in the current year. While disappointing, this puts it on a price-to-earnings (P/E) ratio of 8. This indicates that Debenhams has a wide margin of safety which could provide downside protection in an uncertain environment, as well as scope for significant capital gains should the effects of Brexit prove to be more positive than expected.

In addition, Debenhams is a sound income stock. Its dividends are expected to be covered almost twice in the current year, which means that its yield of 6.4% is relatively safe. There may be more stable dividend stocks around which offer higher growth prospects for shareholder payouts, but Debenhams's high, well-covered yield makes it a worthy income play.

A wide margin of safety

Also facing a difficult operating environment is Pearson(LSE: PSON). The educational provider is expected to report a fall in its bottom line of 21% this year, which reflects its transition towards becoming a lower cost and simpler business. As part of this, Pearson is in the process of reducing headcount by around 4,000 and is on-track to record annualised cost savings of £350m. This should help to boost next year's financial performance, with Pearson expected to deliver a rise in earnings of 16%.

This high rate of growth is likely to be boosted by weaker sterling. As Brexit negotiations start next year, it would be unsurprising for uncertainty among investors to increase and for the pound to weaken further. This would benefit Pearson since it operates mostly outside of the UK and yet reports in sterling.

Pearson's price-to-earnings growth (PEG) ratio of 0.8 provides evidence of its wide margin of safety. Certainly, there is a risk that its strategy fails to ignite stronger earnings growth in 2017 and beyond. However, since it has been successful so far and Pearson is cheap, it seems worthy of purchase for the long term.

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Peter Stephens owns shares of Debenhams. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


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