Buying cheap FTSE 100 stocks can be a great strategy to build wealth. Blue-chip shares that trade below value can rise strongly over the long term and deliver returns way ahead of the broader market.
Yet some companies carry low valuations due to their high-risk profiles, or poor earnings outlooks. These sorts of stocks trade cheaply for good reason.
These particular FTSE shares trade on low price-to-earnings (P/E), or price-to-earnings growth (PEG) multiples. Are they top value stocks, or potential money pits?
Barclays
The Barclays (LSE:BARC) share price sprang higher last week as first-quarter numbers beat forecasts. Thanks to the boost from higher interest rates, pre-tax profits came in at £2.6bn during the period.
With inflationary pressures persisting, it seems the Bank of England could continue hiking rates well into 2023. This is good for banks as it boosts the difference between what they offer savers and what they charge borrowers.
However, those first quarter numbers also revealed an alarming rise in loan impairments. Due to trouble at Barclays’ US cards business, these shot up to £524m from £141m in the same 2022 period. Bad loans were also higher than the £498m recorded in the final three months of last year.
With consumers and businesses feeling the pinch on both sides of the Atlantic I fear that impairment levels could remain a problem for the business. And as interest rates likely fall at some point in the second half, Barclays could struggle to grow earnings.
The steady progress of challenger banks in winning customers — and the huge investment in areas like technology that established banks are making to compete — is another big danger to profits. And this is one threat that looks set to plague Barclays over the long term.
So I’m happy to avoid this FTSE share despite its low P/E ratio of 5.4 times for 2023. Not even the addition of a 5.5% prospective dividend yield is enough to tempt me in.
Entain
Investing in ‘sin stocks’ like gambling companies can also pose big risks to investors. The threat of regulatory action that could hamper their operations and smack earnings is never far away.
For Entain (LSE:ENT), the dangers to its UK business are rising as the government takes steps to change current gambling laws. Proposed amendments, include slapping a 1% levy on industry revenues and capping online slot machine stakes at £2 to £15.
But I feel that the low valuations of some operators more than reflect this danger. Take Entain, which trades off price-to-earnings growth (PEG) ratios of 0.1 and 0.2 for 2023 and 2024 respectively. Any reading below 1 indicates that a stock is undervalued.
It’s my opinion that Entain could deliver explosive profits growth over the next decade. It has strong brands like bwin and Ladbrokes that are enabling it to win business in the fast-growing online market.
These helped the number of active customers rise 19% in the first quarter and hit all-time peaks.
I’m also encouraged by the FTSE 100 firm’s ongoing expansion in key markets like the US. Net gaming revenues (NGRs) at its BetMGM division in the States leapt 76% in the first quarter. This illustrates Entain’s massive growth potential in overseas territories.
