I’ve ranked all of the current members of the FTSE 100 — excluding investment trusts — using two popular valuation measures.
The first is the price-to-earnings ratio (P/E), the other is the price-to-book ratio (P/B). I’ve combined the two lists to come up with my top 10 cheap Footsie shares.
And the winner is …
Top spot goes to Vodafone (LSE:VOD) but its inclusion is a good example of why such metrics and company accounts can sometimes be misleading.
For the year ended 31 March 2023, it reported earnings per share (EPS) of 42.77 euro cents. But this included one-off gains of €9.3bn, following the disposal of some of the group’s operations.
Excluding these gives an adjusted EPS of 11.45 euro cents. Reflecting the lower figure would result in the stock falling three places on my list.
BT is currently fourth. And the inclusion of another telecoms stock helps illustrate a wider problem that’s affecting valuations in the sector.
The industry requires an enormous amount of investment but, due to intense competition and rising interest rates, earnings are not keeping pace.
To address the problem, Vodafone is currently undergoing a restructuring exercise that will see it exiting markets where the cost of financing its operations is higher than the returns generated. I expect most of these proceeds will be used to reduce its huge borrowings.
I already own shares in Vodafone so I’m watching the company’s turnaround plan with interest. But due to my exposure to the sector, I don’t want to include BT in my portfolio as well.
A balancing act
All five of the banking stocks in the index make the top 10 – NatWest Group (2nd), Barclays (3rd), Lloyds Banking Group and Standard Chartered (joint 5th), and HSBC (8th).
Although a higher interest rate environment is generally good for their revenue, it also increases the number of loan defaults.
Economists appear to agree that interest rates have now peaked — anticipated reductions will cause banking margins to shrink. But I believe the sector still offers good value. That’s why two of the stocks are in my ISA. However, at the moment, I don’t want any more exposure to the sector.
The others
Seventh place belongs to British American Tobacco. With its excellent track record of generous and reliable dividends, the stock’s popular with income investors. Of course, payouts are never guaranteed. The company is hugely cash generativ, which is helping fund its transition away from traditional tobacco products. But I have concerns that increased restrictions on new alternatives will harm its long-term prospects. I therefore don’t want to buy.
National Grid is ninth. It also pays healthy dividends. And its monopoly status in its key markets means it doesn’t have the problem of finding new customers. But the downside is that it’s regulated and is restricted on what it can charge. I rate the stock highly and it’s on my watchlist for when I next have some spare cash.
Tenth spot goes to Kingfisher, owner of B&Q. The company’s had a torrid time lately. In November 2023, it issued its second profits warning in two months. The business is struggling in France, which is weighing on its earnings and share price. It’s likely that all of the bad news is now out in the open but, until the picture becomes clearer, I’m not interested in investing.
