3 Bumper Bargains Among The FTSE's Big Boys

Published in Investing on 21 August 2012

Global giants go on sale.

Today, the FTSE 100 (UKX) as a whole trades on a price-to-earnings (P/E) ratio of 11.2 -- not expensive, but not exactly screamingly cheap, either.

Run your eyes down a list of the top 20 shares making up the index, and it's certainly possible to spot shares on P/Es much higher than that average. Diageo (LSE: DGE), for instance, trades on a trailing 12-month P/E of over 25. British American Tobacco (LSE: BATS), to choose another example, has a P/E of 21.

But intriguingly, three of the FTSE's very largest shares are on a P/E that's much lower. Much, much lower -- and lower than the FTSE's average.

Size is everything

In outline terms, it's not difficult to guess why. "Elephants don't gallop," famously wrote growth investor Jim Slater. And to be sure, shares don't come much more elephantine than the upper reaches of the FTSE 100 -- especially the top 10.

But look more closely, and these shares are trading on bargain P/Es that are also due to other factors. Simply put, these shares are relatively unloved, with P/Es that are both below their industry averages, as well as below their own five-year highs.

But is that lack of love justified? For the most part, I think not. Especially when -- in terms of market capitalisation -- two of the three shares in question make up the two single largest companies in the index. Indeed, as we'll see in a moment, ranked by revenues, two of these three are also in the top five of the Fortune Global 500.

So unloved, maybe. Minnows, definitely not. And about to go 'pop'? Most certainly not. The three shares in question? Let's take a look.

Global giants

Company% of FTSE 100Today's priceForecast P/EHistoric P/E
Royal Dutch Shell (LSE: RDSB)9.8%2,336p8.78.4
HSBC (LSE: HSBA)6.9%566p9.79.9
BP (LSE: BP)5.7%450p7.67.8

Source: Bloomberg

  • Royal Dutch Shell ranks first in the Fortune Global 500 for revenues -- in other words, businesses don't come any bigger. It operates in 80 countries around the world, owns over 30 refineries and chemical plants, has 43,000 retail filling stations, and produces 3.2 million barrels of gas and crude oil each day.
  • HSBC isn't quite the world's largest bank by revenues -- ING, BNP Paribas and JP Morgan Chase are bigger -- but even so, it serves around 60 million customers worldwide through 6,900 branches and offices in 84 countries. That said, it wins out on one ranking: HSBC has the distinction of having paid out more in dividends than any bank in the world over the past five years.
  • BP is another global giant, being ranked the world's fourth-largest company in terms of revenues according to the Fortune Global 500. Active in 30 countries worldwide, it operates 16 refineries and 21,800 retail sites, and owns country- or regional-specific brands such as Aral, Arco and Castrol. Still defined by its problems in Russia and the Gulf of Mexico, BP has the muscle to shoulder aside such difficulties, and go on delivering shareholder returns for decades.

Opportunity

Slightly further down both the FTSE 100 and the Fortune Global 500 is another British business, also with a global footprint, that is also trading on a beaten-down P/E. So much so, that it's caught the eye of Warren Buffett, who only rarely makes forays outside of the United States.

What's more, Buffett now owns over 5% of this share -- and has been taking advantage of market weakness to top up more. This free special report from The Motley Fool -- "The One UK Share Warren Buffett Loves" -- highlights the compelling investing thesis that Buffett has seen. Why not download a copy? It's free, and can be in your inbox in seconds.

Want to learn more about shares, but not sure where to start? Download our latest guide -- "What Every New Investor Needs To Know" -- it's free. The Motley Fool is helping Britain invest. Better.

More investing ideas from Malcolm Wheatley:

> Malcolm owns shares in BP, but not in any other companies mentioned here.

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Comments

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ProfessorMarcus 21 Aug 2012 , 5:05pm

Hi Malcolm.

It would be helpful to me, as a relatively inexperienced investor, if TMF could publish articles that provide more in-depth evaluation techniques and not just provide suggestions based on low P/E ratings.

These companies will be trading at lower P/E ratios for a reason, and although this could be used as a basis for further investigation it'd be a decent educational exercise if people were shown how more experienced investors also factor in other company attributes.

Cheers.

MDW1954 21 Aug 2012 , 5:14pm

ProfessorMarcus,

Fair point, but companies don't always have lowly ratings for a reason. GSK, for instance, was unloved for a longwhile. Nothing has changed in its business or financials, but it's now seen as a buy. Tesco is the new whipping boy today, with a drop in share price that seems to me out of all proportion to the newsflow.

BP, I'd suggest, is down to Russia and GoM, as the piece says. HSBC is down to banks, which aren't flavour of the month. RDSB is more of a puzzle.

Malcolm (author)

ProfessorMarcus 21 Aug 2012 , 5:32pm

Thanks for the reply Malcolm.

But my point was that it would be good if TMF could display WHY good companies like GSK were, and Tesco are at the moment fundamentally sound companies that are being down-rated erroneously.

If I were to create a portfolio of FTSE100 companies today based on low P/E ratings then I'd be top heavy with insurers and miners/oil companies. I need to know whether the likes of Aviva, BP. etc. are unloved because of the potential, real, or unfounded risks involved.

And rather than make a subjective decision I'd rather be supported by facts and figures.

Cheers.

vinchainsaw 21 Aug 2012 , 5:32pm

What I find fascinating is the following:
From LSE website:
RDSB PE ratios:

2006: 7
2007: 6.5
2008: 5.3
2009: 17.6
2010: 10.8

Unfortunately they dont go back any further than that. Based on that, however, RDSB seems to be fairly priced at present.

Disclosure: long RDSB

vinchainsaw 21 Aug 2012 , 5:36pm

Similarly HSBC:

2006: 10.3
2007: 7.9
2008: 6.5
2009: 32.2
2010: 13.8

And BP:

2006: 8
2007: 8.8
2008: 7.2
2009: 10.5
2010: N/a

I appreciate these are point in time PEs and through a pretty stormy time, yet nevertheless, they dont seem wildly different to what we have today.

jackdaww 21 Aug 2012 , 5:41pm

ProfessorMarcus

good question - reluctant answers - keep on persisting !

i have a substantial chunk of RDSB - bought at 1680 - which i hope is a margin of safety.

ProfessorMarcus 21 Aug 2012 , 5:58pm

Hello jackdaww.

I bought BP for about 590p in 2006 as I thought it was fairly valued at the time.

I'm still trying to build a 'costing/evaluation' mechanism to evaluate potential stock purchases but I'm finding that it's easy to be struck by 'analysis paralysis' i.e. - overwhelmed by too much information and conflicting strategies.

But on the flip-side I want to make a judgement based on more than one metric.

Regards.

MDW1954 21 Aug 2012 , 7:15pm

Hello jackdaw,

You mention "reluctant answers". I answered nine minutes after the first comment, which in any case wasn't a question. Now, at 7:15pm, I see there's a follow-up, which *is* a question. We do have lives to lead, you know!

Malcolm (author)

MDW1954 21 Aug 2012 , 7:19pm

Professor Marcus

Why does the market fall out of love with a share, and write down the rating? Market psychology, I guess. I'm more concerned with spotting shares trading on a mis-pricing, than worrying about why that mis-pricing has occurred.

Malcolm (author)

john10001 22 Aug 2012 , 12:51am

I thought HSBC was now second biggest in the world after ICBC? Is the article accurate?

BP and RDSB good companies to invest in at the moment especially the former. I would stay well away from banks though. Forever. Period.

jackdaww 22 Aug 2012 , 9:00am

MDW1954

sorry i didnt mean reluctant in the tardy sense - but in substance - ie more factors other than p/e alone.

no rush.

vinchainsaw 22 Aug 2012 , 9:40am

Malcolm,

I think that is what Prof Marcus is actually asking.
How do you identify a mis-pricing and distinguish it from a company that perhaps has fundamental problems down the line that is being reflected in the current share price.

Simply going on PEs and the like doesnt take account of, for example, the patent cliff facing AZN.
Or the prospect of stalling growth at Tescos, perhaps an expectation that oil prices will fall for Shell or European exposure for Aviva.
Or something closer to home, like a weak management structure, a disruptive competitor that will eat the incumbent's lunch etc.

My personal opinion is there is always a reason a share is under-priced. My only goal is to decide if the market is giving these problems a fair assessment and pricing it as such, or whether the market has over-reacted.
If 95% of the market is institutional investors, these guys are typically doing a lot more work than average Joe and are normally much more experienced and have access to information that the man on the street simply doesnt have. They have complex forecasting models that look at far more than a PE (maybe economic forecasts, correlations between markets etc), access to top investing minds and access to company execs. If they are mis-pricing an asset then an amateur investor needs to question why.

I think the honourable Prof is simply asking how you weigh all these factors up after identifying a low PE share.

Personally I bought Tescos on the dip last year as I thought the market was over-reacting to poor UK sales, whilst overly discounting the value of their overseas operations, something I saw first hand when visiting Asia last year.
Similarly, I didnt buy BP and rather plumped for Shell as I wasnt sure at the time what the eventual fall-out for BP would be in the Gulf disaster. I think I got that wrong, but c'est la vie.
AZN I wouldnt touch right now as I've run the numbers for their P&L and the likely hit they'll take due to patent expiry on one drug only, being Seroquel.

In short (I think) he's asking about how much consideration you give to factors not contained in the PE in your personal investing.
There are, of course, other writers on the Fool that give scant regard to any factors other than numbers and fair play to them. I reckon if you're consistent and disciplined in your approach you should be okay.


MDW1954 22 Aug 2012 , 9:49am

Hello john10001,

You ask: "Is the article accurate?"

Here's my data source:

http://money.cnn.com/magazines/fortune/global500/2012/full_list/index.html

Where's yours?

Malcolm (author)

ProfessorMarcus 22 Aug 2012 , 10:17am

Hi vinchainsaw.

Yes, you've comprehensively and accurately articulated my comments/questions from yesterday!

Regards, PM.

TMFTigger 22 Aug 2012 , 12:20pm

Hi PM

I think P/E ratios can help in this regard, but you need to look at both the historic version based on past profits and prospective P/Es based upon broker forecasts.

AstraZeneca, as mentioned previously, is quite a useful example in this respect. You can see from our fundamentals page that its historic P/E is 6.5 but its forecast P/E is 8, as profits are expected to decline as some of its major drugs come off patent.
http://www.fool.co.uk/caps/quote/azn/fundamentals.aspx

(The page I linked to does mix up £ and $ amounts unfortunately, but the higher prospective P/E does indicate the profit decline quite well.)

So, a combination of the historic P/E and the expected growth rate in profits can shed a little more light on why a share is rated at a particular multiple.

To take things further, you would need to project profits for a number of years ahead and ideally look at cash flows rather than profits. Certain companies, e.g. those that operate a single mine or oilfield, may only have a few years of profits before the resource is exhausted. Drug companies face similar problems, but will have other products in development that may replace lost sales when a drug's patent expires. Other companies, like Unilever for example, should get repeat sales/profits year after year.

However, this can all get quite subjective, and is one of the reasons the P/E is used as a shorthand.

If you look at most shares though, you'll see that their prices vary over the course of each year, despite the actual company performing pretty much the same over that period. Shares drift in and out of fashion, and one of our aims as investors is to spot when these drifts become too exaggerated.

For more in depth discussion, I would recommend asking on our discussion boards (perhaps Investment Strategies). We also look at such questions within our Share Advisor service.

Hope that helps

Stuart

ProfessorMarcus 22 Aug 2012 , 12:31pm

Thanks a lot for the reply Stuart.

IMHO it'd be beneficial if future TMF articles such as these have links and references to sources of more information and debate (including relevant TMF discussion boards).

Regards.



ChrisFarrell21 22 Aug 2012 , 12:47pm

The writers on this site get a lot of grief for the articles - some of it warranted WB/NW adverts - but it doesn't appear to be the point of the articles to tell readers where to look to do their own further research. The DYOR qualification should be enough. The website is full of links to the discussion boards, in which Fools provide endless sources of information.

Some of the articles are somewhat pointless lead-ins for the MF's advertising but most of them should be taken at face value for what they are - starting points for decent ideas on where to look next, or how best to do it.

Anything after that is our responsibility.

rober00 22 Aug 2012 , 4:51pm

I totally agree with ChrisFarrell21 both re pointless MF advertising articles and re links etc.

I would add that I find Malcolm one of the best writers on the MF and one of the least likely to write pointless articles (certain other MF writers take note).

There are more than enough pointless distracting MF links for my liking and enough books available on investing fundamentals elsewhere.



MDW1954 22 Aug 2012 , 9:21pm

Hello rober00,

Needless to say, I'm in full agreement! :-)

Malcolm (author)

jaizan 22 Aug 2012 , 10:22pm

There are several studies out there showing buying low PE ratio stocks tends to result in outperformance (check Twedy Browne, "What has worked in investing" for example).
So examining low PE stocks is a fair strategy.
Disclosure: I hold BP and RDSB.

goodlifer 23 Aug 2012 , 12:32pm

rober00

"There are...enough books available on investing fundamentals elsewhere."

Maybe, but it's not as if they all agree what these fundamentals are.

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