Value-hunting investors may be finding it harder and harder to find true bargains in the FTSE 100 these days as the index has risen in value by nearly 12% since January, stretching valuations across many sectors. That’s why BT (LSE: BT) is one of the more intriguing shares in the index, trading as it is at a sedate 13 times earnings while offering a steady 3.6% yield.
So, with a relatively low valuation and hefty dividend should bargain hunting investors pile into BT shares now?
I’d advise caution. First, the telecom giant’s shares are currently trading above their recent historical average valuation. Second, the reason BT’s shares are priced at a loftier valuation is because the company is embarking on a rather dramatic gamble to gin up more growth.
BT’s ambitious plan is to begin challenging the likes of Sky and Vodafone in the high margin market for quad play packages offering landline, mobile, internet and pay TV subscriptions to customers. This has meant dishing out over £12.5bn for mobile provider EE and billions more buying the rights to air the Champions League and a several dozen Premier League matches a year.
Now, BT isn’t necessarily wrong to make this move. If regulators do eventually force the telco to hive-off Openreach, its subsidiary which controls the vast majority of broadband pipes in the country, the company would lose its biggest cash cow. Over just the past quarter Openreach provided a full 52% of BT’s free cash flow, showing just how profitable a monopoly can be.
For bargain hunting investors who value big, safe companies with steady cash flow and dividends, BT’s transformation project means it may be a completely different business in just five years time. While this forward-looking project is necessary, given increased political scrutiny of Openreach, would-be investors should be wary as the company piles on debt and pins its future on a highly competitive, capital-intensive sector of the market.
Valuations are going the other way for Prudential (LSE: PRU), where price/earnings ratios are now at their lowest level since 2012. The market’s newfound negativity for the insurer and asset manager is down to its high exposure to China and fears that growth in the developed world may be peaking.
The upside for bargain hunters is that all this negativity means not only are Prudential’s shares relatively cheap, but they also offer a solid 2.9% yield. But is the pessimism around Prudential’s future warranted or completely overblown?
Well, the insurance industry is a cyclical one, but since we don’t know when the net recession is going to arrive it’s better to focus on Prudential’s underlying business. Here the outlook is quite bright. Despite recent bearishness towards Asia in general and China in particular, Prudential’s exposure to these increasingly wealthy markets is a major bonus. And, while dramatic headlines may have us think otherwise, Prudential’s Asian business is still generating massive profits. Over the past six months operating profits from the region grew a full 15% year-on-year
As incomes in major markets such as China continue to grow by leaps and bounds, increasingly wealthy middle classes represent a huge potential market for Prudential’s life insurance and asset management services. With steady income from trans-Atlantic businesses and the long term potential to be found from Asia, Prudential may be worth a closer look for bargain hunters.
