Between Brexit and the pandemic, UK shares still look cheap from a global perspective. The price-to-earnings ratio of the Dow Jones Index in the US is 32. That compares to around 23 for the FTSE All Share index. That is one reason I am looking for cheap UK shares to buy now. Here are two I’ve been buying this year.
An out-of-favour engineering firm
Looking at the chart for engineering conglomerate Babcock (LSE: BAB) can be demoralising. For many years the company’s shares have kept falling. Last month things took a turn for the worse, after the company announced that it may need to write down the value of some contracts.
So, why is this among my list of cheap UK shares to buy now?
I think the warning of the potential write-down was actually good news, not bad. It wasn’t signalling that the business value has dramatically deteriorated, in my interpretation. Instead, it showed that a new management team were taking a disciplined look at how best to account for the company’s performance. I see that as being like a dentist telling me I need a filling. The news may be hard to take, but it’s better for me than just saying nothing.
Until we get a clearer sense of what Babcock’s future earnings are likely to be, it is hard to say whether the valuation is fair or not. However, the company’s shares now suggest a company valuation of just £1.3bn. That seems low for a company with long-term relationships with customers like the Royal Navy as well as a £16.8bn order book.
Babcock could yet turn out to be a value trap. Past earnings aren’t indicative of future earnings, especially if the board decides that prior accounting methodology isn’t the best one for the company to use in future. Some analysts worry that to raise cash, the company could need a rights issue. I do think that is a possibility, but continue to see value in the company’s assets. Directors buying shares last month also boosted my confidence in my own purchase.
Imperial Brands is among the cheap UK shares to buy now
If there was a bank account offering a 10% interest rate, the Sunday papers would be full of it.
But cigarette maker Imperial Brands (LSE: IMB) offers roughly a 10% yield and continues to see its share price in the doldrums. Now, a yield isn’t the same as an interest rate. There is no guarantee that it will be sustained, and indeed last year the company cut its dividend level. Added to that, the company’s focus on cigarettes worries some analysts given the structural shifts in cigarette usage in many markets.
Despite all of that, I still have Imperial on my list of cheap UK shares to buy now. The company owns brands such as Rizla and John Player Special. While cigarettes are declining in developed markets, it continues to have pricing power. The company’s recent strategy session with investors indeed emphasised plans to offset volume declines by continuing to click prices up.
Meanwhile, it continues to pay out a quarterly dividend which yields close to 10% at the current share price. For me it’s a cheap UK share hiding in plain sight.
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christopherruane owns shares of Babcock International Group and Imperial Brands. The Motley Fool UK has recommended Imperial Brands. 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.