When searching for cheap shares, I like to hunt for value in the FTSE 100. That’s because the UK market’s main index is fairly cheap by historic standards. This is partly due to fears over potential economic damage from Covid-19 lockdowns and a no-deal Brexit.
Cheap shares: the FTSE 100 is inexpensive today
One way to identify cheap shares is to examine their CAPE Ratio. This is similar to the familiar price-to-earnings ratio, but measures the 10-year average of inflation-adjusted earnings. This smooths out short-term market movements, making it easier to spot long-term valuation discrepancies.
As this user-friendly chart from Barclays shows, the UK stock market currently has a CAPE Ratio of 14.14, versus 32.07 for the US. In other words, investors are willing to pay 2.27 times as much per unit of US earnings as for one UK unit. For me, this indicates that the US market might be too expensive, while the UK is a haven for cheap shares.
Tellingly, the UK market’s CAPE ratio is as low today as it was in September 1990 and March 2003. For the record, the UK stock market went on to soar dramatically after both of these historic lows.
Inexpensive shares lurk within the FTSE 100
Given the uncertainty over the UK’s immediate future, it isn’t surprising that the FTSE 100 is filled with cheap shares. But the index is at the same level today as it was in mid-1998, which is somewhat shocking to me!
Of course, investors like me could just buy the whole FTSE 100 by investing in a low-cost index tracker. However, there are cheap shares in the Footsie that, to me, offer compelling value for patient investors. Take, for example, investment management firm M&G (LSE: MNG), which entered the FTSE 100 last October following its demerger from Prudential.
As one of the smaller FTSE 100 members, M&G’s shares have been extremely volatile. Having peaked at 245.9p on 19 February, this stock then crashed to an all-time low of 84.12p by 18 March. At this point, the stock was crazily, spectacularly, remarkably cheap, in my eyes. M&G’s share price then zigzagged along before dipping to 146.15p on 24 September. In the past month, it has bounced back, leaping 11.5% in four weeks.
Are M&G shares still a bargain today?
On Friday, M&G shares closed at 168.8p, valuing it at £4.4bn. This leaves M&G’s share price at twice the level it hit in the March market meltdown. Yet despite doubling from their all-time low, I think these remain cheap shares today.
Based on forecast earnings, M&G stock trades on a price-to-earnings ratio of 4.1, for an earnings yield of 24.4%. What’s more, its dividend yield is a bumper 7.1%, offering a mouth-watering cash return for income investors. Lastly, M&G aims to generate at least £2.2bn in excess capital over the next three years. Much of this sum — equal to half its current value — will be returned to shareholders in capital returns and extra cash payouts.
I believe M&G’s stock is one of the cheapest shares available in today’s climate. Yes, it’s a small player in a highly competitive industry facing pressure from lower fund fees and investor withdrawals. Yet I see today’s bargain price as more than adequate reward for taking on this risk. That’s why I’d buy and hold these cheap shares, ideally in an ISA to enjoy a flood of tax-free dividends and capital gains!
Cliffdarcy has no position in any of the shares mentioned. The Motley Fool UK has recommended Prudential. 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.