There is nothing like buying shares at a discount. This allows me to buy a larger number of shares and hopefully make capital gains over time as their prices rise. But selecting cheap UK shares to buy is not always as simple as it appears. This is because there are various ways to define what a cheap UK share is, to start with.
Is a low absolute share price a good measure?
It can appear that the lowest priced UK shares are also the cheapest. But that need not be so. A company can choose to issue as many shares as it likes. And if it issues a larger number of shares, then the price per share can be quite low. For instance, Lloyds Bank has a share price of around 44p as I write, which is way lower than that of its peer Barclays, which is at 179p.
Lloyds Bank may look cheaper, but that is because the number of shares held by investors is far larger than that for Barclays. If both banks had the same number of shares, then their share prices would not be very different from one another.
Consider relative prices
Another way to look at the same example is by comparing the price-to-earnings (P/E) ratios for both shares. Lloyds’s P/E ratio is 6.7 times, similar to 6.8 times for Barclays. This means that in relative terms, they are similarly priced. If anything, both banking stocks are cheap compared to many other FTSE 100 stocks, including mining and healthcare ones.
Comparing with the past
A third way to figure out if a share is cheap is by comparing it to its earlier price. Again, consider the example of Lloyds bank here. It is still way below the 60p levels it started 2020 with. Despite a pick up in the economy and its own financials, it is however trading at much lower levels. To me, it looks like a genuinely cheap share to buy for now, which is set to rise over time.
Not all cheap UK shares are made the same
However, not all cheap UK shares may rise over time. Sometimes, there can be genuine reasons holding stocks back. Examples of these include travel stocks that still face some uncertainty. We are not completely out of the woods as far as the pandemic goes and their financials are still in a funk. The risk to buying them is reducing as travel increases, but it still persists. So I have to think carefully before buying these shares.
Also, stocks may suddenly start looking cheap for purely technical reasons like a stock split or a rights issue. But in actual fact, little may have changed. So I would be careful before making buying decisions based on any such sharp changes in share price without first finding out why it happened.
