Everybody loves to spot a bargain and investors scouring stocks are no different. But what many new investors fails to understand is that there is a difference between shares which are ‘cheap’ and those which offer genuine value.
To help in identifying undervalued stocks, there are a number of ratios to look at. In this article, we will see which shares are cheap based on P/E ratios, PEG ratios and Price to Book ratios
1. Price to Earnings Ratio (P/E)
P/E Ratio = current share price / earnings per share
If Company A currently has a share price of 100p and is forecast to generate earnings
per share of 20p in 2017 it is on a prospective PE of 5. (100 / 20 = 5)
The P/E ratio is arguably the most used by investors when researching stocks. It is a relative measure which can be used to compare individual stocks against their peer group, a sector or the wider market. The P/E compares the market value of a company with its profit.
When looking at the P/E ratio a figure above 20 is generally considered to be a
premium rating while shares trading at 10 or below are considered to be cheap.
It is important to understand that if a P/E ratio shows a particular stocks as being cheap, it usually means that there is something wrong with the company. It could mean that the company has too much debt, or is pursuing a wrong strategy or is becoming technologically obsolete. Companies are usually cheap due to investors having no or low faith in a companies prospects.
Below is a list of 10 stocks that are cheap when compared to their average PE over the last 10
years. The premise of this is that if a share is trading on a lower than average PE due to a short-term poor performance, then it could rise sharply to return its previous rating when things get back on track.
Company Discount of Current Forward P/E To 10 Year Average
- Mitchells & Butlers 70.7%
- Capita 52.7%
- Petrofac 51.1%
- Shire 46.3%
- Kenmare Resources 40.6%
- Next Fifteen Communications 39.3%
- Centamin 37.8%
- Berkeley Group 37.7%
- Bovis Homes 37.6%
- Anglo American 37.5%
2. Price to Earnings Growth Ratio (PEG)
PEG = prospective PE ratio / forecast earnings per share growth
The PEG ratio takes the P/E ratio once step further by factoring in the growth prospects of a firm. So if company A has a P/E of 30 and is growing at 100% a year whilst B has a P/E of 15 but is only going at 2% a year, company A offers far better value than company B.
When looking at the PEG ratio figure, a number between 0 and 1 means a stock is
cheap relative to its growth prospects and anything above 2 means it is looking fully valued.
Have a look below for 10 cheap stocks as found by the PEG ratio
Company Forward PEG
- Rolls-Royce 0.3
- Cairn Homes 0.3
- Highland Gold Mining 0.3
- Helical 0.3
- Imagination Technologies 0.3
- FBD Holdings 0.3
- Royal Bank of Scotland 0.4
- Tesco 0.4
- RSA Insurance 0.4
- Balfour Beatty 0.4
3. Net Asset Value Method (NAV)
PNAV = share price / NAV per share
NAV (net asset value) = (Total Assets – Total Liabilities) / Shares Outstanding
If Company A’s share price is 100p and it has 100 million shares outstanding. Its net asset value (NAV) is £60 million which equates to NAV per share of 60p. Therefore its price to NAV ratio is 1.67. ( 100 / 60 = 1.67)
For companies that are asset intensive, it is better to value them based on the assets they have as opposed to the awnings they generate.
The P/NAV ratio helps compares the share price to the ‘per share’ value of its assets. This shows the cost of a stock relative to the value of the company if its assets were broken up and sold. This metric is often used to compare stocks in the real estate space or other companies with significant financial assets.
Below are 10 cheap companies by P/NAV
Company Price to NAV
- Barclays 0.6
- Royal Bank of Scotland 0.6
- Millennium & Copthorne Hotels 0.6
- Drax 0.6
- Cairn Energy 0.6
- Standard Chartered 0.7
- Land Securities 0.7
- British Land 0.7
- Intu Properties 0.7
- Debenhams 0.7
When it comes to investing valuation matters. If you overpay for a a great company, your returns will be substandard. Conversely, if you pay a cheap enough price for an average company you can still end up with a great return. So that next time you are thinking about purchasing a stock, have a look at the various valuation matrices to check whether you are getting a genuine bargain