Recent volatility on financial markets means many UK blue-chip shares trade well below value. The FTSE 100 alone is packed full of brilliant bargain shares following falls in March.
As investors it can be sometimes tricky to separate truly terrific cheap stocks from value traps. Some shares trade at low cost owing to their high risk profiles.
With this in mind, here are two FTSE index shares I’m avoiding right now.
Lloyds Banking Group
Forward P/E ratio: 6.4 times
Dividend yield: 5.6%
I’ve long taken a dim view on UK-focused banks such as Lloyds Banking Group (LSE:LLOY). The domestic economy is tipped for a prolonged period of weak growth due to significant structural issues. These include problems like low productivity and post-Brexit trade frictions.
It seems the market shares my pessimism, too. This is why the Lloyds share price (like those of Barclays and NatWest) trade on lower price-to-earnings (P/E) ratios than emerging market-led operators HSBC and Standard Chartered.
I think British banks may struggle to grow profits and dividends over the long term. And their troubles will likely be worsened by interest rates returning to the levels of the 2010s.
The International Monetary Fund says that the recent rise in Bank of England rates will prove “temporary”. It reckons borrowing costs will retrace to pre-pandemic levels once inflationary pressures ease.
The lower interest rates are, the smaller the margin between the interest banks charge borrowers and offer to savers. This can be a significant drag on bank profits and explains why Lloyds’ share price remained weak following the 2008/09 financial crisis.
I like the steps the bank is taking to boost profits through steady cost-cutting. I also I think its huge exposure to the housing market will pay off handsomely over the long term as home demand grows. The company has long been Britain’s biggest mortgage provider.
But on balance I believe buying Lloyds shares is a risk too far.
Tesco
Forward P/E ratio: 12.5 times
Dividend yield: 4%
Historically, Tesco (LSE:TSCO) has been seen as a rock-solid share for UK investors. Food retail is one of the most stable sectors out there. And this particular operator sits at the top of the tree.
This is thanks in part to the firm’s long-running Clubcard loyalty scheme. It ensures a steady flow of customers through its doors and its website. And it could remain a big money spinner for the business.
Yet I won’t be buying Tesco shares due to intensifying competitive pressures it faces. Amazon is eating into its online business, while store expansion at Aldi and Lidl is sapping store revenues.
Of course the company’s traditional rivals are also ramping up the attack to steal customers. Today Sainsbury’s, for example, announced plans to offer lower prices on many products for members of its own Nectar loyalty scheme.
If this proves as popular as the similar ’Clubcard Prices’ programme, Tesco might have another big problem on its hands. It has the potential to heap even further pressure on its rival’s wafer-thin profit margins.
The company trades comfortably below the average forward P/E ratio of 14 times for FTSE 100 shares. But even at these cheap prices I’m not tempted to buy Tesco shares.
