With the stock market having re-rated upwards significantly over 2013, it’s more difficult than ever to find stocks that scream value on an absolute basis.
However, SSE (LSE: SSE) (NASDAQOTH: SSEZY.US) could prove to be an example of a company that is cheap based on its relative valuation to the wider stock market.
Indeed, SSE currently trades on a historic price to earnings (P/E) ratio of 11.2, which doesn’t sound too high on an absolute basis.
However, when compared to the FTSE 100, it becomes clear that SSE could be good value on a relative basis, too. For example, the FTSE 100 currently trades on a P/E of 13.7, which means that SSE trades at a discount of 18.2% to the wider market.
Of course, some of this discount may be deserved, because of the political risk that comes with investing in utilities. Opposition leader, Ed Miliband, recently stated that if Labour win the next election there will be a price freeze on energy bills and a new, tougher regulator will be set up.
So, while SSE does deserve a discount to the wider index, a discount of 18.2% sounds rather large.
In addition, SSE continues to offer a yield that is significantly above the average yield of the market. While the FTSE 100 currently yields 3.4%, SSE has a dividend yield of 6.4%.
This equates to a premium of 88% over the FTSE 100 yield and, although SSE is undoubtedly a defensive share that should offer a yield premium to make up for below average earnings growth over the long run, such a premium seems excessive — even when the additional political risk is taken into account.
Indeed, were SSE to trade on a yield of 5.5% (still a premium of 61% versus the FTSE 100 yield), it would mean shares trade at around 1530p, which is 16% higher than the current share price.
Add to that the current yield of 6.4% and it appears as though a potential total return of over 20% could be on offer for investors in SSE. Certainly, the political risk is evident but, based on risk versus reward, this could prove to be an attractive stock.
Peter owns shares in SSE.