The FTSE 100’s a great place to look for bargain shares. The London stock market’s blue-chip shares have underperformed significantly in recent years, a reflection of weak economic conditions and political turbulence in the UK.
But investors need to be careful before piling into cheap stocks. Some low-cost FTSE 100 aristocrats have delivered brilliant returns in years gone by. Yet their current weak valuations reflect the challenges they face going forwards.
Here are two Footsie legends I won’t touch with a bargepole next month.
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Tesco
You’d think Tesco (LSE:TSCO) could be a dead cert to grow earnings as the UK’s population rapidly expands. In theory, more mouths to feed should translate to higher grocery sales, not to mention greater demand for the company’s non-edible items.
The Office for National Statistics thinks Britain’s population will swell by 9.9% in the 15 years to 2036, to 73.7m.
The problem is that competition in the supermarket sector’s extreme and growing rapidly. And it’s not just the scourge of the German discounters that’s a threat to Tesco’s earnings.
In recent days, Retail Gazette announced fellow mid-tier retailer Morrisons plans to substantially expand its own store estate, opening 400 new Morrisons Daily convenience stores to take the total to 2,000 by 2025.
Tesco’s performance against its rivals has been more promising of late. Its market share actually grew 52 basis points, to 27.6%, in the three months to 25 May. But it could struggle to keep this momentum as its rivals rapidly expand, attracting Tesco’s customers and prompting it to slash prices.
Today, Tesco shares trade on a forward price-to-earnings (P/E) ratio of 12.2 times. While well below their five-year average of 20.3 times, I’ll still leaves the supermarket on the shelf today.
Lloyds
I’m also planning to continue giving Lloyds Banking Group (LSE:LLOY) shares a wide berth. On paper, the Black Horse Bank offers even better value than Tesco shares. It trades on a forward price-to-earnings (P/E) ratio of 8.7 times. And its dividend yield for 2024 stands at a market-beating 5.7%.
Signs of steady recovery in the housing market bode well for Lloyds, the UK’s biggest home loans provider. And things could get even better as interest rates will (likely) fall later in the year.
But, overall, I believe the outlook for retail banks like this is pretty gloomy. Rate cuts will pull down the margins they make on their lending activities. Meanwhile, longstanding structural problems with the British economy could put a cap on earnings growth.
And, like Tesco, the business faces growing competition, in this case from challenger banks like Monzo and Starling Bank.
Finally, Lloyds specifically also faces significant charges if it’s found to have mis-sold motor finance products. It’s already taken a £450m charge in a worrying reminder of the hugely expensive PPI scandal of the 2010s.
There are plenty of cut-price stocks on the FTSE 100 today. So I’m not tempted to take a chance with high-risk Tesco or Lloyds shares.
