FTSE 100 stocks haven’t offered much in the way of growth over the past 12 months, with few exceptions.
And this is why so many FTSE 100 companies trade with low multiples. For example, the UK lead index has a forward price-to-earnings (P/E) ratio of 15.2, while the S&P 500 has a forward P/E ratio of 20.6.
This is because the FTSE 100 is generally seen as a more mature market, with companies not as growth-oriented as those on the S&P 500.
As such, low P/E ratios can be misleading, or something of a value trap.
So unless I’m being well remunerated in the form of dividends, I want to invest in companies that aren’t just cheap by today’s earnings, but cheap based on their earnings potential.
PEG ratio
The price/earnings-to-growth (PEG) ratio is a valuable tool for stock valuation, combining the current price-to-earnings (P/E) ratio with anticipated earnings growth.
In fact, I’m starting to think it’s the most important tool I have at my disposal for assessing stocks and their value.
The PEG ratio represents the stock’s price divided by expected earnings growth rate over three-to-five years, with a ratio below one indicating undervaluation.
However, it’s essential to acknowledge that the PEG ratio has limitations. One concern is its presumption of a linear relationship between P/E and growth, as well as the dependency on forecasts.
Cheapest FTSE 100 stock
So what is the cheapest FTSE 100 stock using the PEG ratio? Well, it’s important to note that there really aren’t that many stocks on the index with a PEG ratio below one. It’s just not a growth-heavy index and is why many investors prefer to look to the S&P500.
With the Roll-Royce share price rallying to £3 in recent weeks, the cheapest company on the index is now Tesco, according to this particular ratio.
The supermarket giant, which is already up 27.3% over the past 12 months, has a PEG of 0.47. That indicates the company is undervalued by more than half.
In the table below I’ve highlighted earnings per share forecasts and the associated impact on the forward P/E. The data from 2024-2026 are the consensus forecast.
| 2023 | 2024 | 2025 | 2026 | |
| EPS | 22 | 23.3 | 24.5 | 26 |
| P/E | 13.1 | 12.5 | 11.9 | 11.2 |
As we can see, growth is expected to be fairly strong over the coming three years, and assuming the PEG ratio is based on a five-year growth rate, beyond that.
Investors may be concerned about the impact of inflation on food prices, and the challenges that can create.
However, Tesco is in a commanding position in the UK. In fact, it’s market share has expanded around 0.5% since the height of the cost-of-living crisis. The firm has also been far less impacted than its peers by the entry of Aldi and Lidl into the UK.
I’m yet to invest in Tesco, but it looks like a great opportunity. I’m hoping to find an entry point in the coming weeks.
