Like any savvy investor during a correction, I’m looking for stocks to buy at bargain prices. That’s right, the UK market is officially in a correction after the FTSE 100 dipped more than 10% from recent highs.
As scary as that seems, it’s not a crash — yet. That would be a 20% drop. But if it dips further, we could get a rare opportunity to buy solid companies at even better prices.
But remember, a low share price on its own doesn’t necessarily mean good value. Fortunately, valuation metrics help us understand if we’re looking at a genuine bargain or just a troubled business.
Valuation metrics explained
The most common valuation metric is the price-to-earnings (P/E) ratio, comparing the share price to the past year’s earnings. Anything lower than about 15 suggests undervaluation. The price-to-book (P/B) ratio compares the share price with the company’s net assets. Anything below 1 suggests a low price compared to asset value.
The P/E growth (PEG) ratio can also help, evaluating growth against price. Below 1 indicates earnings growth is outpacing the price.
These measures are usually ‘trailing’, based on past results. Forward-looking ratios, such as the forward P/E, use analyst earnings forecasts instead. If the forward P/E is much lower than the trailing one, the market expects earnings to grow. But forecasts can be wrong, especially in a shaky economy.
Discounted cash flow (DCF) models go a step further, estimating future cash flows and comparing them to today’s share price to gauge value.
Two stocks looking cheap by earnings
Legal & General‘s (LSE: LGEN) share price has fallen 13.3% in the past month, even though earnings are up 177% year on year and return on equity (ROE) sits at a healthy 16.3%. It trades on a trailing P/E of 30, with a much lower forward P/E of 9.9, and a PEG of just 0.17.
Together, these suggest the market’s expecting solid profit growth from here.
A DCF model implies the shares are around 68.5% below fair value – strong growth potential if those cash flows materialise.
Recent full-year results show operating profit up and good capital generation. However, its Solvency II coverage ratio has ticked down, adding risk.
Other risks include regulatory changes, market volatility, and the chance that profit growth or capital strength disappoints.
Hochschild Mining shares have dropped 24% over the past month, with earnings up 101% year on year and ROE a punchy 29.8%. The trailing P/E is 18.7 and the forward P/E is 7.5, while a DCF model suggests the stock trades 46.6% below fair value.
This reflects strong cash generation helped by higher precious metal prices. Recently, it reported its strongest ever financial performance, with revenue and profit both climbing sharply with gold and silver prices.
However, miners are always risky as profits depend on volatile commodity prices, costs can overrun, and geographical risk is ever-present.
Final thoughts
Both companies look worth considering after today’s market has pushed their valuations down while profits remain strong. But prices can always fall further, even when a stock looks cheap on paper.
Valuation metrics such as P/E, PEG and DCF are helpful starting points, yet they only tell part of the story. Before investing, it’s important to look at the business strategy, sector demand, and the strength of the management team.
