When hunting for value stocks on the FTSE 100, certain metrics can help narrow the search. A good starting point is comparing earnings per share (EPS) to the current price.
This shows how accurately the market’s valuing a stock, known as the price-to-earnings (P/E) ratio. It’s presented as a number measuring the price per share in multiples of EPS. For example, a P/E ratio of 5 means the price is five times higher than EPS.
A very high ratio (30+) suggests the market may be overly exuberant about a stock’s potential. This can be risky, because if the company misses earnings expectations, the price can fall rapidly.
Alternatively, a low ratio suggests pessimism but can lead to a rapid price rise if earnings beat expectations. Value investors typically aim to capture this growth potential.
Hunting value
I use a screener with a set of metrics to quickly pull up value stocks. Aside from the P/E ratio, I also check the price-to-book (P/B) ratio, analyst forecasts, and debt-to-equity ratio, among others.
Together, these show not only if the stock is undervalued but if it has sufficient recovery potential.
One promising stock that recently popped up on my screener is 3i Group (LSE: III), the London-based private equity and investment firm. The price has slipped by around 22% over the past three months, resulting in a very low P/E ratio of just 5.1.
Considering 3i is typically a high-growth stock, the low price is an opportunity worth considering. But before jumping in, it’s crucial to ask: why is the price falling, and will it recover?
Short-term weakness
The share price took a huge hit after 3i posted weak half-year results in November. The results revealed diminishing revenue from one of its largest holdings, discount retail chain Action.
Since the company makes up two-thirds of 3i’s portfolio, it adds significant concentration risk. Any shortfall at Action directly hurts 3i’s price. Sales have fallen in recent months following stiff competition from rivals like B&M European Value and low-cost Chinese e-commerce stores such as Temu.
Despite a more positive trading update last week, the price hasn’t managed to recover — yet. But a brief look at the company’s numbers tells me there’s a good chance it will.
Strong financials
Action’s sales slump should not be taken lightly — any further declines could significantly impact 3i Group. But for now, the group as a whole remains highly profitable, with a return on equity (ROE) of 25% and eye-wateringly high margins.
Revenue has increased 62.8% year-on-year and yet remains almost 20 times lower than the enterprise’s £35bn valuation. EPS is up 50% year on year and debt, at £1.25bn, is minimal compared to £28.2bn in equity.
A siutation like this is extremely rare — an exceptionally profitable, highly liquid business that’s trading 62% below fair value based on future earnings estimates. Yes, Action’s concentration adds risk — but enough to bring down the whole business? I doubt it.
Like many other analysts, I expect the price to fully recover this year. Most 12-month price targets fall between 3,000p and 5,200p, with the average of 4,194p representing a 27% gain. I think it’s one to consider.
But that’s not the only undervalued opportunity I’ve spotted on the FTSE 100 this year.
