Companies trading at discounts to their long-run valuations tend to become takeover targets. And there are plenty of FTSE 100 companies trading at these discounts at the moment.

The index might be at new highs but, by many metrics, UK stocks are still trading at discounted valuations.

One recent example of a discounted UK stock becoming a takeover target is Hargreaves Lansdown. The stock has surged following a rejected big by a private equity consortium. However, this isn’t the company I’m looking at today.

Buying a stock that’s a takeover target can be attractive due to the potential for immediate gains, but I wouldn’t buy a company purely in the hope a takeover will help me out.

Additionally, the underlying strengths that make the company a target suggest solid fundamentals, offering the potential for long-term gains. Market sentiment and increased liquidity can further enhance the attractiveness of investing in such a stock.

Valuation makes it vulnerable

Analysts believe that luxury fashion house Burberry (LSE:BRBY) could one day be subject to a bid as the share price drops to new lows. abrdn investment manager Sasha Kachanova recently noted that Burberry was a target due to its valuation.

“As the sole British brand of scale operating independently – a rarity in the luxury industry – it boasts a rich heritage and the opportunity to enhance its iconic product lines and accessories,” Kachanova said.

A 2023 Bloomberg survey also highlighted Burberry as one of the most likely options for a takeover in the fashion and luxury goods sector.

It keeps getting cheaper

Burberry stock is now down 53.4% over the past 12 months. It’s among the worst performers on the index and could be relegated to the FTSE 250.

The company, like many of its peers in the luxury sector, is facing several headwinds. Revenue fell 4% in the year to 30 March, and sales growth turned negative in the highly lucrative Asia-Pacific markets. China, naturally, is a major part of these headwinds.

The group’s adjusted operating profits fell 34% to £418m. Meanwhile, earnings per share (EPS) tumbled 41% to 73.9p. As such, the stock’s currently trading around 14 times earnings, broadly in line with the index average.

Analysts however, aren’t expecting much in the way of earnings growth from Burberry. EPS is expected to come in at 78p in 2024, 60p in 2025, and 80p in 2026.

Despite the falling share price, it’s still a great company with a unique brand identity.

Sector consolidation

Burberry operates in a sector where many luxury brands have already been brought into larger umbrella companies, such as LVMH and Kering. These are huge organisations with deep pockets. It’s certainly possible.

For me, buying Burberry was one of my least calculated investments. Without a takeover, it may take a long time for the company’s performance to improve and the stock price to turn around. Nonetheless, I’m hopeful that things will improve.