The market crash made many a FTSE share cheap. But just because a share is cheap does not mean it is worth buying. Cheap shares in good companies are what long-term investors should be looking for, and a simple stock screen can help find them.
Shares trading at between 5 and 12 times earnings per share and less than 3 times book value per share can be considered cheap. Companies that have had negative five-year growth rates in either revenue or profit or with market caps of less than £5bn should be screened out.
It’s cheap but is it good?
The screen leaves five companies for consideration: Barratt Developments, Mondi, Persimmon, Rio Tinto, and Ryanair. Barratt and Persimmon are housebuilders, Mondi is a packaging and paper company, Ryanair is an airline, and Rio is a miner.
Similar to my analysis of FTSE supermarket stocks, we can compare these five companies on profitability, return, credit profile, and growth. For each parameter, the best performing company gets five points, and the worst gets one. Averaging the scores for each company will allow a ranking of them in terms of investment attractiveness, with the highest score winning. The table below shows data for each of the five companies.
Persimmon, with a mean of 4.2 and a median of 5, looks like the best investment case. We can also look at how brokers view these stocks. Brokers issue buy, outperform, hold, underperform, and sell recommendations. As of 7 May, 82% of broker recommendations for Persimmon were either buy or outperform, the highest percentage for our group of five.
Building for the future
In scoring highest in the analysis and being overwhelming recommended by brokers, Persimmon looks like a cheap and good company. But given the state of the UK economy at present and the pain that is to come, what does the future look like for housebuilders?
The UK’s listed housebuilders are starting construction again this week, which is good news for the industry. I would imagine finishing off partly built homes will be the priority. Social distancing at building sites and a depressed housing market will make laying new foundations a challenging prospect. Homebuilders will be building less.
Showrooms remain closed, and homebuyers are still cautious about taking on mortgages, which will make the backlog of houses challenging to clear. But things will pick up as the months roll on. Interest rates will remain low, which is a boon for borrowers. The banks are not in trouble like they were in the great financial crisis, and mortgage availability should pick up quickly this time around.
Persimmon focuses on cheaper homes and first-time buyers. Demand for these types of properties tends to bounce back faster. During the last financial crisis, many homebuilders had shocking balance sheets. Persimmon currently operates with very little debt and appears to have ample liquidity.
Cheap stock, good value
I believe that at the current share price, there is an opportunity to buy into Persimmon cheaply. Based on the analysis, broker recommendations, and thinking about the company’s prospects, I think Persimmon looks like a good company. FTSE investors should be on the lookout for cheap shares in good companies.
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James J. McCombie has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.