This P/E Suggests Marks and Spencer Group Plc is a Hold

The FTSE 100 has risen by more than 85% since it hit rock bottom in 2009, and bargains are getting harder to find.

I’m on the hunt for companies that still look cheap, based on their long-term earnings potential. To help me hunt down these bargains, I’m using a special version of the price to earnings ratio called the PE10, which is one of my favourite tools for value investing.

The PE10 compares the current share price with average earnings per share for the last ten years. This lets you see whether a company looks cheap compared to its long-term earnings.

Today, I’m going to take a look at the PE10 of Marks & Spencer Group (LSE: MKS) (NASDAQOTH: MAKSY.US).

Is Marks & Spencer a buy?

Sales of General Merchandise (clothing) fell by 2.4% last year at M&S, and were down by 1.6% on a like-for-like basis in the first quarter of this year.

This year’s autumn/winter collection is about to hit the shops, and will be a key test of the firm’s turnaround strategy, as it’s the first to be designed under the control of the company’s new General Merchandise management team.

As things stand, M&S remains profitable and offers a reasonable 3.5% dividend yield, but does it look cheap against historical and recent earnings?

Marks & Spencer 14.7 14.3

These figures suggest to me that M&S is fully valued against both its last year’s earnings and its historical average earnings.

The firm’s earnings per share have fallen from 38p to 29p over the last three years, and analysts’ consensus forecasts suggest underlying earnings of 33.1 this year, giving a forward P/E of 14.5.

Wait and see

Marks & Spencer’s stock price has climbed by 25% this year, double the 12% gain delivered by the FTSE 100. To me, this suggests that some recovery has already been priced into the stock, so I would be wary of investing without any concrete evidence of progress.

On the other hand, holders of M&S shares who paid less than 400p per share are currently enjoying a dividend yield on cost of 4.25% or more, which is considerably higher than the FTSE 100 average of 3.0%. This is enough, in my view, to justify continuing to hold the shares for longer-term gains.

Overall, I rate Marks & Spencer as a hold, as I think the upside and downside risks are evenly balanced at the moment.

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> Roland does not own shares in any of the companies mentioned in this article.