The FTSE's 5 Cheapest Shares

Published in Investing on 8 July 2011

They all trade on P/Es of 7 or less.

Sometimes, the simple things work best -- and I've certainly found that to be the case when it comes to successful investing.

So, in the spirit of zooming out a little to take a look at the wider picture, I ran the simplest of screens -- a price-to-earnings (P/E) test of the FTSE 100 companies.

Is this too simplistic?

Well, yes it is. But if we mix a little top-down macro thinking with a bottom-up approach of individual company value, then a P/E screen is a good base for people such as me who think the economic outlook is reasonably encouraging. 

For the bears and value-hunters (and I still include myself in the latter group), a slightly more sophisticated way of doing things would be that suggested by Stephen Bland -- running three mechanical filters: P/E, yield and price-to-book value.

But as Stephen says: "As always with my value style, a light touch is all that is needed to make decisions... less is more."

Even less can be more

So a simple P/E screen is even less. And if you're bearish and worried about our collective macro-economic picture, the approach of protecting the downside first on a price-to-book value is a wise one. Similarly, if you're at least partially dependent on dividends to keep you fed and watered, as I am, then a concentration on dividends is also vital.

But if you're more interested in capital growth based on future earnings, and are happy with a light-hand-on-the-tiller approach (for which read: you have life away from your computer!), then a simple P/E screen, with the deliberate exclusion of other factors, has merit as a starting point for further research.


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Sometimes, cheap is cheap

This is particularly true if you think we're in for a steady market climb. Sometimes, cheap is cheap.

And in my opinion, the higher up the food chain we search, the more reliable the search results -- hence my confining of the screen to the FTSE 100.

Whether you follow the screen's findings to the letter, or prefer to overlay them with a little qualitative judgement of your own, is up to you. I prefer the latter.

Running the screen based on consensus broker forecasts for 2012, the five stocks with the lowest forward P/Es are:

CompanyShare priceForward P/E ratio
Aviva (LSE: AV)438p6.2
BP (LSE: BP)464p6.3
Barclays (LSE: BARC)250p6.3
Eurasian Natural Resources (LSE: ENRC)810p6.4
BAE Systems (LSE: BA)315p7.3

For the record, just outside the top spots are Royal Dutch Shell (LSE: RDSB) at 2,273p per share with a P/E of 8.2, and AstraZeneca (LSE: AZN) at 3,146p per share with a P/E of 8.6. I believe that if we include these two companies, the seven shares listed would make a reasonably good starting point for a long-term portfolio.

There is a mix of sectors, and the list is also quite defensive, but I feel the seven offer some scope for growth at the same time.

Always a reason

Of course, there are usually good reasons why such monolithic companies find themselves trading on a low P/E. AstraZeneca for instance faces increased competition following the expiry of exclusive rights to its treatments; the so-called 'patent cliff'. Personally, I see this more as an opportunity to buy a cheap, low-rated share, than a threat.

As for Aviva, this has long retained the top spot in Stephen Bland's value portfolio, and it isn't difficult to see why when you look at the numbers. But we should be careful here when looking at earnings figures alone; other indicators are generally more reliable for insurers.

It isn't surprising to see Barclays up there. The banks' troubles are well known and uncertainty over legislative changes remains -- though I believe the falls in this particular sector have been overdone.

So there we are -- a very simple approach, but maybe an effective one. I'll look again at the list in six months' time to see how it's faring.

More from David Holding:

David owns shares in AstraZeneca, Aviva, Barclays, BP and Royal Dutch Shell. The Motley Fool UK owns shares in AstraZeneca and BAE Systems.

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mcturra2000 08 Jul 2011 , 1:30pm

"the list is also quite defensive"

Not sure I'd buy that argument. AV and BARC are cyclic. AV's EPS is actually less than it was a decade ago (54.2p for 2010 cf £56.1p for 2001), for example. BP. and (I assume) ENRC are heavily dependent on the price of commodities, so whether they are good value is dependent on whether or not you think we're still in a "commodities supercycle".

BA. and AZN are, I would think, the only ones that could be classified as defensive.

Jimi97 11 Jul 2011 , 5:32pm

IMO, the above demonstrates why a low PE is a big red light for me (as is a very high value). With the possible exception of Aviva, I see all sorts of good reasons NOT to invest in the companies listed!

closeddoors 13 Jul 2011 , 11:40pm

This advice should be taken with a pinch of salt! it just doesent make any sense, if all the other banks are trading at 1/5th of Barclays share price where can it possibly go from here?

closeddoors 13 Jul 2011 , 11:45pm

I made a 20% return purchasing USOP on the plus market the other day while others shares were tumbling

firsthippo 14 Jul 2011 , 5:20pm

I would like people recommending shares also to state the levels of debt and cash flow as these may be risk warnings. They may be the reason for low p/e. Have not many sound businesses gone bust due to insufficient cash flow? Is this not the cause of our economic crisis?

mcat1000000 17 Jul 2011 , 10:25am

Depending on your reason for investing should determine which metric is more applicable to you.
Capital gain - choose a value metric as outlined above.
Income - choose a share whose yield you are satisfied with
Retirement income in 20 years time - just choose a solid boring share with a solid dividend above the long-term inflation rate of 3.5% and dividend growth above 3.5% and just keep re-investing the dividend.

There is a rather strange quirk here.
With the retirement income approach, the share price becomes irrelevant as the investment will be yielding 20% or more.
Who in their rght mind would sell something yielding 20% plus?

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