The godfather of value investing, Ben Graham, made a lot of money for investors by focusing on a firm’s historic earnings.
One of Mr Graham’s preferred valuation techniques was to divide a company’s current share price by its ten-year average earnings per share. Doing this tended to smooth out the effects of market cycles and short-term problems, and highlight companies that were trading cheaply compared to their historic profits.
This valuation ratio is known as the PE10, or the Cyclically Adjusted PE ratio (CAPE). For private investors, finding this figure isn’t easy, and you usually have to calculate it yourself. However, it’s not difficult, and can be very worthwhile.
Three companies which are currently out of favour but have seriously low PE10 ratios are Barclays (LSE: BARC), Morrisons (LSE: MRW) and Asia-focused bank Standard Chartered (LSE: STAN).
Barclays
Barclays trades on a PE10 of just 6.9, reflecting how far below historic levels the bank’s current earnings are.
This isn’t the only value indicator that suggests Barclays could be a buy. The bank’s shares trade on a 2015 forecast P/E of just 10.9, falling to 9.3 in 2016. Barclays’ price-to-book ratio is currently just 0.75.
On top of this, Barclays’ recovery is going quite well, it’s just taking a little longer than expected. Earnings per share are expected to be 24p this year, a level not seen since 2010.
In my view, all these factors combine to make Barclays a classic value investment.
If Barclays was valued with a still-modest PE10 of 10, its share price would be about 375p. That’s around 50% higher than it is today.
Morrisons
Morrisons shares currently have a PE10 of 10. Although this isn’t as cheap as Barclays, I believe it is an attractive valuation.
Morrison’s trading statements over the last year have consistently showed that the firm is making slow but steady progress with its turnaround. Net debt has fallen, there is less reliance on promotional sales and the group now has a sophisticated online shopping system.
Although the dividend had to be cut, the shares offer a reasonable forecast yield of 3.2% and trade at just 1.1 times their book value. With half-year results due on 10 September, it might be wise to wait until then before trading, but I believe Morrisons remains a buy.
Standard Chartered
Asia-focused bank Standard Chartered has been battered by the recent stock market sell off. Concerns have been focused on the growing weakness in the commodity and emerging market sectors, to which Standard Chartered has heavy exposure.
However, a Ben Graham value investor would note that Standard Chartered currently trades on just 6.5 times ten-year average earnings. Like Barclays, Standard Chartered only trades on around 10 times 2015 forecast earnings. Like Barclays, the shares trade around 30% below book value.
A lot of pessimism seems to be baked into the bank’s share price. In my view this has been overdone. Standard Chartered has a long reputation and a new boss who is determined to return the company to its previous level of success.
With a forecast dividend yield of 4.9%, I believe Standard Chartered is a very attractive buy in today’s market.
