The current average price-to-earnings (P/E) of the FTSE 100 is 13.88. The P/E is the ratio of a company’s share price to its earnings per share (EPS) and it’s calculated dividing the stock’s current price by its EPS.
A low P/E can suggest that a stock is undervalued or that it’s cheap for a reason. A high P/E suggests a company has high growth potential, or it could just be a bit expensive.
So, today I’m looking at FTSE 100 stocks trading at multiples below 7 — roughly half the average.
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Banks
UK banks and other financial institutions are among the cheapest on the index using the P/E ratio. There are several reasons for this.
First, the economic forecast doesn’t look all that great right now. The IMF said this week that the UK would likely be the only G7 economy to contract in 2023. Recessions mean more bad debt for banks and higher impairment costs.
It’s also worth noting that UK banks haven’t been that popular with investors for some time. Maybe it was the financial crash all those years ago, but equally, Brexit is a factor as its becoming clear that Britain is economically worse off outside the EU.
So, that’s why we can see banks, especially the UK-focused ones, trading with lower P/Es. Lloyds trades with a P/E of seven, Barclays five.
I see both these stocks as good purchases and I believe that they’re undervalued rather than cheap for a good reason. Discounted cash flow calculations suggest they’re undervalued by around 60% (Lloyds) and 70% (Barclays).
In the near term, there’s also the matter of higher interest rates. These have provided banks with huge tailwinds in recent months. They even earn more from holdings with the Bank of England (BoE). In the case of Lloyds, analysts suggest it earns £200m in revenue from every 25 basis point hike.
I’m already well invested in both stocks, but I’m looking to buy more.
Housebuilders
I’ve been holding off purchasing housebuilding stocks for some time now. House prices are broadly stalling and potential buyers are deferring their purchases. Reasons include the end of the Help to Buy scheme, little sign that interest rates will fall before H2, and the cost-of-living crisis.
Meanwhile, double-digit inflation is putting margins under increasing pressure. This stubborn inflation also means that interest rates will likely stay high, causing further demand-related challenges.
As a result, housebuilder shares have tanked over the past year. Persimmon, for example, is down 40% and it now trades with a P/E of just 5.7. Barratt Developments has a P/E of 5.5.
And right now, I think these stocks are cheap for a reason. There could be some more challenges in the coming months, before things improve. So, when it comes to housebuilders, I’m keeping my powder dry for now.
