UK shares look incredibly cheap. The FTSE 100 has a price-to-earnings (P/E) ratio of 14.5. In other words, 14-15 years of earnings equals the amount that’s invested. Compare that to the US S&P 500 P/E average of 27.3.
On this valuation metric, at least, British shares are nearly half the price of American ones. No wonder so many British firms are being eyed up as takeover targets.
Given the apparent bargain state of many shares in this country, is this the best place to consider investing? Are low P/E shares always better? Can we get real, hard data on the matter? Well, the answer is yes, we can.
Ancient wisdom
A famous, if old, work can get us started. The Intelligent Investor by Ben Graham. In this book, Graham ran a test comparing the 10 lowest P/E stocks to the 10 highest. In every five-year period, the low P/E stocks outperformed the market and the high P/E stocks underperformed. There’s more to the book than that single finding, but it’s a pretty famous result and helped popularise the concept of value investing.
There’s a big caveat here though. That book was written in the 1960s. Time have changed a bit since then, so let’s try and find something a touch more relevant to the modern day.
Another report I found came from Merrill Lynch examining the same trends but from 2010 to 2019. Interestingly, it found the opposite result. Low P/E stocks underperformed the market. One primary reason given was that investors were chasing lower P/E stocks. This imbalance caused any advantage to be lost as prices rose. Another reason was the dominance of high P/E tech stocks over the decade.
What does this all mean for me then? For one, it’s a good reminder that there’s much more to any stock than just one metric. Looking at P/E or anything other single data point is a recipe for failure. That said, the P/E metric has worked in the past and is a good starting point when looking at a stock.
Cheap as chips?
Take Barclays (LSE: BARC) for instance. The bank has a P/E of 9.17 at the moment. That sounds low compared to the Footsie average. It also looks low to a commonly given fair value of 15. It seems truly low compared to US banks’ average of 17.5. This information is hardly comprehensive, but it’s a nice springboard for anyone looking for cheap shares to buy.
Its cheapness has been reflected in a good year for the share price, up 53%. With interest rates expected to stay higher for longer, I can see this performance continuing over the long term too. Remember, banks benefit when interest rates are higher as there’s more scope to increase their margins.
While risks abound – the threat of bankers engaging in some 2000s-style speculation with 2000s-style consequences being one – I’m happy to have a stake in the bank myself.
