The FTSE 100 reached a new all-time high yesterday of over 8,000. This means the combined value of shares in the 100 biggest companies on the London Stock Exchange is higher than ever. But that doesn’t mean they’re overvalued. In fact, I’ve got good reason to think there are lots of cheap shares on offer right now.
Footsie looking cheap?
A great starting point to sniff out cheap shares is to use the price-to-earnings ratio (P/E ratio). This tells us how much it costs to buy a share of a company compared to the earnings the company makes. A share cost £13 and the earnings per share is £1 over the last 12 months? That’s a P/E ratio of 13.
With a P/E ratio of 13, I might expect a company takes 13 years to return my stake in earnings.
So what’s a good ratio? Well, I can compare the P/E ratio to the cyclically adjusted price-to-earnings (CAPE) ratio, which is a 10-year average of the P/E ratio (sometimes called a P/E 10 ratio). This table shows the data for the FTSE 100, along with a comparison of the US S&P 500.
| FTSE 100 | S&P 500 | |
| P/E ratio | 14.2 | 19.2 |
| CAPE | 22.7 | 29.7 |
This tells me the FTSE 100 valuations are looking cheap compared to their recent historical average, and also compared to US stocks. And I can use the same process to find cheap shares – undervalued companies that might offer excellent long-term returns.
Three potential gems
Industrial metals and mining firm Glencore trades at an extremely low P/E ratio of 5.31. Mining is a mature industry with less room for growth, so I would expect it to be lower. But the P/Es of similar firms like Rio Tinto at 6.87 or Anglo American at 9.43 show that this might be a good investment. Combine this with increasing revenues and a healthy 4.4% dividend and it seems like Glencore may be undervalued.
Multinational oil and gas behemoth Shell has a P/E of 5.33. It’s a company that’s not popular with investors who follow ESG (Environmental, Social and Governance) guidance to make ethical stock choices. For this reason, and the incentive to move away from fossil fuels in the future, the figure in this case might be low because it’s pricing in future problems.
Looking towards the FTSE 250 with smaller-cap stocks, the British media company ITV has a P/E ratio of just 7.48 while also offering an extremely attractive dividend of 5.6% to shareholders. The problem? The supposed upcoming recession will affect its ad revenues, and the company has high debt due to an investment in its new streaming service ITVX – a service that could prove to be a big winner down the line, however.
Not a foolproof strategy
It’s important to bear in mind that looking at price-to-earnings is just a starting point. Sometimes there’s a good reason the share price is cheap. For example, a company might have high levels of debt. But I’m convinced that in spite of the FTSE 100 hitting 8,000, there are still lots of cheap shares available in the UK right now.
