How to Find Value-Based Cheap Stocks UK
Many investors would have heard the phrase ‘buy low, sell high.’ However, it is far easier said than done. A low share price or cheap stock may be a good place to buy low or it may keep on going lower.
Judging whether a stock is cheap or not can be a difficult process. However, there are some valuation metrics that investors use to help in their decision making which explore in this ‘How to Find Value-Based Cheap Stocks UK’ article.
Table of Contents
What are Cheap Shares UK?
Cheap UK stocks are companies whose share prices are trading at a historically low level relative to what they should be worth. Why would a stock become cheap? A good company with strong long term prospects may be hit by some bad news which can cause its share price to fall making the stock cheap to some investors.
Identifying what is a cheap stock or not can be subjective. This is why investors try to standardise the analysis of a company’s worth by using different types of valuation metrics. To identify cheap stocks, some investors would use value investing techniques.
Value investing is a way of identifying cheap stocks that are trading at a discount to their intrinsic value. The most famous value investor is Warren Buffett who tries to invest in companies that are trading lower than what they should be worth.
Finding Cheap Stocks UK Using Valuation Metrics
There are hundreds, if not thousands of different financial ratios that investors use to identify if a company is undervalued and a cheap stock to buy. Below are a few common metrics used to identify the cheapest stocks UK.
Earnings per share (EPS)
Earnings per share (EPS) measures how much money a company is earning relative to the number of shares available. It is calculated by dividing a company’s profit by its outstanding shares.
EPS = (Net Income – Dividends) / Outstanding Shares
The EPS is a common way of estimating the worth of a company as it is directly related to its level of profitability. A higher EPS indicates more value because investors are willing to pay more for a company’s shares if they believe it is making a high level of profit relative to its share price.
As with most financial metrics, the EPS is more valuable when comparing it to other companies within the same stock sector or industry.
Price to Earnings (P/E) Ratio
The price earnings ratio is calculated by diving the company’s share price by its earnings per share (EPS). The ratio helps determine whether a stock is undervalued or not by comparing the company’s stock price to the profit it is making.
A high PE ratio could mean that the company is overvalued, whereas a low PE ratio could mean it is undervalued. However, the P/E ratio by itself doesn’t paint the full picture. It is more effective to compare the price earnings ratio to different companies in the same sector.
For example, comparing the price earnings ratio of UK supermarkets can provide more understanding if which ones are underperforming or overperforming.
There are two types of P/E ratios – forward and trailing.
Price to Sales (P/S) Ratio
The price to sales (P/S) ratio is typically calculated by dividing a company’s market capitalisation by its revenue. Effectively, it values a share based on a company’s annual revenue and is useful when comparing the ratio to other companies in the same industry.
Price to Book (P/B) Ratio
The price to book (P/B) ratio measures a company’s market cap to its book value. It is calculated by dividing the company’s stock price by its book value per share. Value investors typically like to see a P/B ratio under 1.0 but it is more useful when compared to other companies in the same industry.
Value-Based Cheap Shares UK to Watch
Below are a few UK shares to watch this year.
1. Barclays (BARC)
Barclays is a financial services company that operates all around the world and offers retail banking, credit, wholesale, investing banking and wealth management services. Founded in 1690, it has 87,400 employees and a market cap of £24.1 billion.
Its current price to earnings ratio of 4.8x is below the industry average of 7.4x suggesting some value based on this metric. When taking the company’s forecasted earnings growth, the stock is trading below is fair price to earnings ratio of 7.4x.
Its current price to book ratio if 0.4x with a price to sales ratio of 1x. The stock price has struggled this year so far due to souring sentiment on banking stocks due to regulators taken control of US based Silicon Valley Bank.
2. Rolls-Royce Holdings (RR)
Founded in 1884, Rolls-Royce Holdings has 41,800 employees with a market cap of £13.0 billion. The company has four segments: civil aerospace, power systems, defence and new markets. This broadly covers the development and manufacturing of aero engines for larger aircrafts, the sale of engines to the military and submarine nuclear power plants and more.
The company’s price to sales ratio is 1x which is lower than the average of its peers at 2.1x and lower than the European Aerospace & Defence Industry average of 1.4x. The industry is forecasted to grow 7.2% with Rolls-Royce forecasted to grow 5.2% during the same time.
The Rolls-Royce share price collapsed more than 90% from its record high in 2014 to its pandemic low in 2020. Since then, the stock has rallied more than 300% higher but headwinds remain for the UK stock market and airline industry due to energy price volatility.
3. Marks and Spencer (MKS)
Marks and Spencer is multinational British retailer that specialises in selling food products, clothing and home products. It was founded in 1884, has more than 78,000 employees and a market cap of £3.1 billion.
Its current price to earnings ratio of 9.8x is below the industry average of 13.3x. When taking the company’s forecasted earnings growth into consideration it is below its fair price earnings ratio of 13.8x.
However, while these valuation metrics suggest an undervalued stock relative to the industry, when analysing its future cash flow using the discounted cash flow model its fair value is £0.91 making the stock overvalued on this metric.
Other Considerations Analysing UK Stocks
Analysing the long-term price direction of a stock can be challenging. It is important to diversify an investment portfolio and keep the risk small to manage both winning and losing investments appropriately. Valuation based metrics is just one way to analyse a company’s worth.
Most investors tend to use a combination of analysis techniques to analyse a stock. This includes fundamental analysis of a company such as analysing sales, product developments and sector strength. There is also the macroeconomic environment to take into consideration as well such as the overall sentiment towards global economic growth.
Investors can also use technical analysis as another tool to analyse a stock. This involves studying historical price activity using chart patterns and technical indicators to understand the relationship between buying and selling activity.
A good way to start is to use a demo trading account. This allows you to practice different analysis techniques and strategies in a virtual trading environment until you are ready to go live.
FAQs on the Cheap Stocks UK
How do I pick a cheap stock?
Picking a cheap stock is difficult because it can be subjective. Some investors use valuation metrics to determine the worth of a company. This includes ratios such as the price earnings ratio, price to book ratio and others.
What are cheap stocks UK?
Cheap stocks are stocks that are trading at a price lower than its fair value. Another term for cheap stocks is undervalued stocks. Value investors try to identify stocks that are trading below their intrinsic value.
INFORMATION ABOUT ANALYTICAL MATERIALS:
The given data provides additional information regarding all analysis, estimates, prognosis, forecasts, market reviews, weekly outlooks or other similar assessments or information (hereinafter “Analysis”) published on the websites of Admirals investment firms operating under the Admirals trademark (hereinafter “Admirals”). Before making any investment decisions please pay close attention to the following:
1. This is a marketing communication. The content is published for informative purposes only and is in no way to be construed as investment advice or recommendation. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and that it is not subject to any prohibition on dealing ahead of the dissemination of investment research.
2. Any investment decision is made by each client alone whereas Admirals shall not be responsible for any loss or damage arising from any such decision, whether or not based on the content.
3. With view to protecting the interests of our clients and the objectivity of the Analysis, Admirals has established relevant internal procedures for prevention and management of conflicts of interest.
4. The Analysis is prepared by an independent analyst, Jitan Solanki, (hereinafter “Author”) based on personal estimations.
5. Whilst every reasonable effort is taken to ensure that all sources of the content are reliable and that all information is presented, as much as possible, in an understandable, timely, precise and complete manner, Admirals does not guarantee the accuracy or completeness of any information contained within the Analysis.
6. Any kind of past or modelled performance of financial instruments indicated within the content should not be construed as an express or implied promise, guarantee or implication by Admirals for any future performance. The value of the financial instrument may both increase and decrease and the preservation of the asset value is not guaranteed.
7. Leveraged products (including contracts for difference) are speculative in nature and may result in losses or profit. Before you start trading, please ensure that you fully understand the risks involved.