This is the FTSE 100’s cheapest stock. Is it worth buying?

Could this be the most undervalued stock in the FTSE 100 (INDEXFTSE: UKX)? Rupert Hargreaves takes a look.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Right now, the median historical P/E ratio of stocks in the FTSE 100 is 13.4. With City analysts forecasting average earnings growth of around 8.5% for the index’s constituents this year, the ratio is set to fall to 12.8 for 2020. 

This is only the median valuation of stocks in the UK’s leading blue-chip index. Some businesses are worth substantially more or less. And one company that is worth considerably less is International Consolidated Airlines Group (LSE: IAG). 

Impressive turnaround

Owner of the British Airways and Iberia brands, IAG is one of the world’s largest airline groups. Over the past 10 years, under the management of CEO Willie Walsh, IAG has been transformed from a money-losing basket case into a tremendously profitable airline business. Last year the company earned nearly €3bn, although this was mainly due to one-off factors. But City analysts are expecting a healthy €2.3bn of net profit for 2019.

Based on these figures, IAG’s return on equity — a measure of business profitability — was 32% last year, which puts the company in the top 10% of the most profitable public businesses on the London market. 

However, despite these attractive profitability metrics, shares in IAG have the lowest valuation in the FTSE 100. At the time of writing, shares in the company are trading at a forward P/E of just 4.2, that’s a discount of 67% to the market average. 

Generally speaking, companies with a higher level of profitability than the rest of the market deserve a premium valuation, but that’s clearly not the case with IAG. The question is why, and if it is worth taking advantage of this valuation anomaly?

Time to buy?

The airline business is quite an unpredictable one. There are so many different factors that can alter earnings. It is quite difficult to predict growth. Analysts have to take into account factors such as fuel costs, currency exchange rates, airport delays, interest rates and even the weather. There’s also the threat of strikes, which IAG currently has to contend with. 

With so many things to consider, airline stocks tend to trade at a discount to the rest of the market because their growth outlook is so unpredictable. Shares in IAG have always been subject to this uncertainty discount, but it has never been as wide as it is today.

Historically, the stock has traded at a multiple of around eight times forward earnings. Based on current growth forecasts, this would imply a share price of 800p, an upside of 90% from current levels. IAG also looks undervalued compared to international peers. For example, the US airline sector trades at a forward P/E of around 7. 

Undervalued

After taking into account IAG’s own valuation history, and the current valuation of its international peers, I have concluded that the stock is significantly undervalued at current levels. While the shares do deserve an uncertainty discount, a discount of around 40% to international peers seems too steep to me.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

After it crashed 25%, should I buy this former stock market darling in my Stocks and Shares ISA?

Harvey Jones has a big hole in his Stocks and Shares ISA that he is keen to fill. Should he…

Read more »

happy senior couple using a laptop in their living room to look at their financial budgets
Investing Articles

How’s the dividend forecast looking for Legal & General shares in 2025 and beyond?

As a shareholder, I like to keep track of the potential dividend returns I could make from my Legal &…

Read more »

artificial intelligence investing algorithms
Investing Articles

Could buying this stock with a $7bn market cap be like investing in Nvidia in 2010?

Where might the next Nvidia-type stock be lurking in today's market? Our writer takes a look at one candidate with…

Read more »

Investing Articles

Is GSK a bargain now the share price is near 1,333p?

Biopharma company GSK looks like a decent stock to consider for the long term, so is today's lower share price…

Read more »

Snowing on Jubilee Gardens in London at dusk
Investing Articles

Could December be a great month to buy UK shares?

Christopher Ruane sees some possible reasons to look for shares to buy in December -- but he'll be using the…

Read more »

Young mixed-race couple sat on the beach looking out over the sea
Investing Articles

Sticking to FTSE shares, I’d still aim for a £1,000 monthly passive income like this!

By investing in blue-chip FTSE shares with proven business models, our writer hopes he can build sizeable passive income streams…

Read more »

Growth Shares

BT shares? I think there are much better UK stocks for the long term

Over the long term, many UK stocks have performed much better than BT. Here’s a look at two companies that…

Read more »

British Pennies on a Pound Note
Investing Articles

After a 540% rise, could this penny share keep going?

This penny share has seen mixed fortunes in recent years. Our writer looks ahead to some potentially exciting developments in…

Read more »