What are value stocks? If we buy a soaring growth stock, and it climbs even higher and we bag a nice profit, then it was good value, right?
Well, that might be true. But value stocks are generally seen as those trading on lower fundamental measures today than the company’s current performance suggests.
The price-to-earnings (P/E) ratio is the most widely used measure. On its own it’s a crude tool, but other things being equal, lower is better.
Low P/E = good value?
Now, a P/E can be low for very good reasons. A firm might be struggling with debt, for example. So we need to work out if a low P/E really means good value, or if there’s something wrong.
Today, I’m looking at five of the FTSE 100‘s lowest forecast P/E multiples.
| Stock | Recent price | 12-month change | 5-year change | P/E ratio |
| Barclays | 155p | -3.2% | -25% | 4.7 |
| BP | 480p | +16% | -18% | 5.4 |
| Centrica | 119p | +54% | -18% | 5.8 |
| Lloyds Banking Group | 46p | +4.9% | -30% | 6.2 |
| Legal & General | 231p | -7.0% | -18% | 7.1 |
Two categories
These fall into two clear categories, finance and energy. And those are perhaps the two most important in the UK economy.
It makes me think there could be two possibilities here. These low values might be justfied if all these companies are in big trouble.
Barclays looks like it’s priced to go bust. But do we really think it will? Could our finance and energy sectors be set to collapse?
That could justify low prices, for sure. But if it happened, we’d have more to worry about than our Stocks and Shares ISAs.
Got it wrong?
There’s another possibility, of course. What if the big investors might have, well, just got it wrong? And what look like good value stocks really are good value stocks?
Suppose the UK is not about to melt down into a recession to end all recessions. Could our banks actually have a cash-rich future?
And might energy firms have years of profits ahead of them? I mean, you can’t even print money without energy.
The market overreacts
Over the years, I’ve learned one key thing about investor psychology. Investors tend to overreact.
When they’re bullish, they can push share prices up too high. And when they’re bearish, they can push share prices too low. And when that happens, it can be a great time to go contrarian.
It doesn’t mean every share on a low P/E is a buy, of course. Sometimes a falling stock does go all the way to zero.
Do our research
But I think times like this are when private investors like us can shine. If we dig into low-P/E value stocks, we can find some great buys for the long term.
So what about these five here? The two sectors do face a lot of uncertainty this year. And I can see volatile prices for a while yet.
But for an investor who understands the risk, I think any of them could make a nice addition to a diversified Stocks and Shares ISA.
