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We use four key metrics to help spot bargain investment opportunities
Thursday 04 May 2017 Author: Tom Sieber

Everyone loves a bargain and investors are no different. What you must understand is that there is a difference between shares which are ‘cheap’ and those which offer genuine value.

There are several tools at your disposal to identify value and we’ll look at four key metrics in this article to help spot investment opportunities.

Looking at ratios such as price-to-earnings (PE) will provide you with a starting list, but you will then have to look at each individual company to see if it is cheap for a (negative) reason.

Some stocks can either stay cheap or get even cheaper leaving you out of pocket. Therefore research is of upmost importance if you want to be a ‘value’ investor.

A classic example

Back in August 2014, newspaper publisher Johnston Press (JPR) could have looked an absolute steal at first glance on a PE of 6.1 times, based on forecast earnings.

The shares have since lost more than 90% of their value as the market has continued to punish the company for declining advertising revenues and its hefty debt pile. Johnston Press now trades on a 2017 PE of just 1.5 times.

A proper analysis of the company would have revealed why the shares were cheap but not good value.

Let’s now look at four valuation metrics and how you can apply them to your investment research. In each category we will discuss relevant stocks and give you some interesting ideas.

WHY STOCKS RE-RATE AND DE-RATE: A lesson on the importance of PE ratios

The most widely used and understood measure of value on the stock market is the PE or price-to-earnings ratio. It is a relative measure which can be used to compare individual stocks against their peer group, a sector or the wider market.

The PE compares the market value of a company with its profit. In this case, the share price represents the market valuation. Earnings per share is used as a measure of profit.


A company’s valuation is also known as its rating. If a share is re-rated it means it is being valued at a higher level because the investment case has improved for some reason, a de-rating typically means the opposite.

A PE above 20 is generally considered to be a premium rating while shares trading at 10 or below could be considered to have a lowly rating.

The metric does have limitations. Market value provides no direct information on how much debt a company is carrying and earnings per share figures can be massaged through clever accounting.

Remember, while earnings and earnings growth are great, it is important to determine if the profit is sustainable and backed up by cash flow.

To refine this crude marker of value, we’ve run a filter over the market to identify stocks which are trading at a material discount to their average PE over the last 10 years.

If a share is trading on a lower than average PE due to a short-term blip in performance then it could rise sharply to return its previous rating when things get back on track.

MAIN FEATURE - Ten stocks

We concentrated our search on stocks which were trading at a 10% discount or more to their 10-year average PE. For some examples, it is possible to justify the disparity.

Shares in oil services business Petrofac (PFC) de-rated when it diversified from its main engineering and construction business in the Middle East into a range of other activities. This action, combined with falling oil prices, contributed to a string of profit warnings. Therefore a lower PE was justified.

Marketing agency Next Fifteen Communications (NFC:AIM) is a fast-growing business. The 39% difference between its forecast and average PE is skewed thanks to its status as an early-stage growth company which generated limited earnings until relatively recently.

A.G. BARR p.l.c. Final Results, 24 March 2015

A.G. Barr (BAG) 618p

Forward PE’s discount to 10-year average: 13.4%

A strong year-to-date rally at IRN-BRU, Rubicon and Strathmore water maker A.G. Barr (BAG) is pleasing.

New investors haven’t missed the boat, as A.G. Barr still trades at a discount to its historical 10 year price-to-earnings average, suggesting the stock remains good value.

The share price is recovering from a period of poor sentiment towards the company, reflecting volatile and promotionally intense soft drinks market conditions as well as worries over the UK Government’s sugar tax proposals.

The encouraging news is A.G. Barr is successfully pivoting towards consumers’ growing clamour for lower and no sugar products.

Chief executive Roger White has announced that 90% of A.G. Barr’s owned brands will contain less than 5g of total sugars per 100ml by the autumn of 2017.

Full year results (28 Mar) revealed 2.7% growth in pre-tax profit and exceptional items to £42.4m on sales up 1.5% to £257.1m. The performance was boosted by a strong second half and management’s unwavering focus on cost control and asset base investment.

We are fans of the company’s differentiated brand portfolio, strong free cash flow and progressive dividend. Although sterling weakness presents a cost headwind, the business is resilient as soft drinks are low ticket items.

Given the current strength of the balance sheet, A.G. Barr will also return up to £30m to shareholders via a two-year share buyback.

a pile of french fries on white background

Capita (CPI) 565p

Forward PE’s discount to 10-year average: 52.7%

At 9.3 times consensus forecast 2017 earnings per share, support services business Capita (CPI) is trading at a more than 50% discount to its average PE rating over the last decade. A key reason behind this discount was a nasty profit warning in September 2016. Numis says now is the time to buy the shares.

We think the company’s problems are both fixable and more than reflected in the share price. We see scope for a recovery as concerns over the debt situation are addressed. However there remains a big question mark over how quickly the recovery will happen.

On 29 September 2016, the firm downgraded its full year pre-tax profit guidance to £535m-£555m versus previous market forecasts of £614m. It pointed to a slowdown in some trading businesses and continued delay in client decision making.

In December 2016, it downgraded profit guidance again blaming further weakness in its IT Enterprise Services arm. The company announced plans to sell assets to repair its balance sheet after some analysts had speculated a rights issue would be required.

Broker Numis expects proceeds of £800m from the disposal of the Capita Asset Services and Specialist Recruitment. It forecasts this money will reduce the company’s net debt to earnings ratio from 2.9 times to 1.7 times by the end of 2017.

Numis also expects Capita to generate £840m of free cash flow between 2017 and 2019, more than 20% of the current market cap.

The potential value opportunity has been seized upon both by company insiders and high profile investors.

Chief executive Andy Parker snapped up nearly £100,000 worth of shares in December 2016 and well-known fund manager Neil Woodford has taken his holding in the company through his CF Woodford Equity Income (GB00BLRZQ513) fund above the 10% mark.

Schroders (SDR) £31.83

Forward PE’s discount to 10-year average: 17.3%

The UK’s largest asset manager Schroders (SDR) grew its assets under management (AUM) by 5% in the first quarter of 2017 to £405.1bn.

A key contributor was the acquisition of wealth management business C. Hoare, which added £2.5bn.

The shares currently trade on 15.3 times forward earnings, a material discount to the 10-year average of 18.7 times. This likely reflects challenges facing the entire asset management industry, including regulatory and structural challenges coupled with changes in investor sentiment.


Asset managers struggled in the last 12 months, in particular, due to political uncertainty over Brexit, followed by the surprise election of Donald Trump as president in November.

However, Schroders has a well-diversified range of products and derives a decent amount of its revenue from outside the UK. Investment bank Liberum notes the firm did well in a difficult year, as it still managed to attract net inflows of £1.1bn in 2016.

Schroders’ foray into the US market could well yield further growth. We also note it is one of the FTSE 100’s most profitable firms by operating margin, according to Bloomberg’s analysis of three-year data to 2016.


The Mighty PEG

The price-to-earnings growth ratio or PEG is used to identify ‘growth at a reasonable price’, also known as GARP.

A firm’s PEG ratio is calculated by dividing forecast PE by the stock’s forecast earnings growth rate.

PEG disciples believe a ratio between zero and one times means a stock is cheap relative to its growth prospects and anything above two means it is looking fully valued.

Ten of the cheapest stocks by PEG

At 100p, Company X is forecast to generate earnings per share (EPS) in 2017 of 10p. That equates to a PE of 10.

In 2016, Company X’s EPS was 8p so forecast EPS growth is 25% when compared against the 10p forecast for 2017. The company is therefore trading on a PEG ratio of 0.4.

(100 / 10) ÷ ((10-8) ÷ 8) × 100) = 0.4

Polar Capital (POLR:AIM) 383p

Forward PEG: 0.4

Specialist asset manager Polar Capital (POLR:AIM) is in the ascendancy after grabbing star fund managers from a rival house and seeing a healthy inflow of money into its funds over the past two quarters. Canaccord Genuity rates the stock as a ‘buy’.

The firm’s update on its assets under management on 13 April show a 27.4% increase over a year to £9.3bn. The recent launch of its Polar Capital UK Value Opportunities (IE00BD81XX91) fund, with the nabbing of highly respected duo Georgina Hamilton and George Godber from rival Miton (MGR:AIM), has helped this growth.

Twelve of its funds sit in Lipper’s (a fund ratings group) top quartile performers since their inception.

Polar looks to set revive earnings growth after a few negative years. Forecasts imply pre-tax profit will jump by £6m to £29m in the year to March 2018, and then hit £35m a year later. 

Lab technician injecting liquid into a microtiter plate

Shire (SHP) £45.80 $59.0566 / 11.4

Forward PEG: 0.6

Rare diseases business Shire (SHP) has had a rocky ride over the last year in terms of the share price, but many analysts are optimistic about the stock longer term.

The acquisition of Baxalta in June 2016 has been crucial for driving up sales in the enlarged group, and 2017 will represent the first full year’s contribution from the biopharmaceutical business.

Shire in February flagged growth across all therapeutic areas and has multiple new product launches expected this year to replenish its portfolio.

Earnings per share are forecast to increase by nearly 20% in 2017. Shire presently trades on a price-to-earnings multiple of 11.4 – so do the maths and you’ll see it trades on a PEG of 0.6. The forecasts also anticipate another strong year of earnings growth in 2018. Goldman Sachs has a ‘buy’ rating and £68 price target.

WHAT ABOUT DEBT? A lesson on the importance of EV/EBITDA

The EV/EBITDA ratio is a comparison of enterprise value (EV) and earnings before interest, tax, depreciation and amortisation (EBITDA).

The enterprise value measures the total cost of buying a business. It is calculated by adding a company’s liabilities (borrowings and pensions) to the market cap and subtracting any cash.

Unlike the PE or PEG, the EV metric can be used to compare companies with different levels of debt.


The EBITDA figure removes the effect of non-cash expenses such as depreciation and amortisation. In theory, these non-cash items are of less significance to investors because they are ultimately interested in the cash flows of a business.

However, depreciation – measuring the decrease in value of an asset over time due to age, wear or market conditions – is a very real cost of doing business in a lot of sectors and should therefore be considered when analysing some companies.


CMC Markets (CMCX) 126.5p


A regulatory clampdown on the contracts for difference industry has left CMC Markets’ (CMCX) shares in the doldrums, down 50% over the past year. You could argue the market has now fully priced in a likely drop in earnings near-term, leaving it at a more appropriate level from which to reappraise the business.

What’s been missed by investors is CMC’s rapid action to replace a potential hit to earnings with a boost to its overseas operations. It announced a partnership in March with ANZ, one of Australia’s largest banks, to power its stockbroking platform including technology, customer service and execution.

Ultimately we believe any prolonged weakness in CMC’s share price could prompt founder and 62% shareholder Peter Cruddas to take the business private again.

Stratford city cafe 1

Marks & Spencer (MKS) 366p


A modest EV/EBITDA ratio of 5.7 for high street bellwether Marks & Spencer (MKS) reflects structural challenges and the uncertainties associated with turning round its Clothing & Home division.

Burdened by debt, M&S also faces rising clothing and food costs as a result of sterling’s weakness versus the US dollar, not to mention higher wage costs, all of which are weighing on the valuation.

The good news is the foods-to-fashion purveyor emerged as a surprise Christmas winner, new CEO Steve Rowe’s third quarter update (12 Jan) showing a long-awaited return to positive like-for-like sales growth in Clothing & Home.

Albeit delivered against some easy comparatives, 2.3% like-for-like growth at least demonstrated Rowe’s turnaround plans for the division are paying off. Prospects over in food are more appetising, with M&S continuing to grow market share in fierce industry conditions.

Asset-backed stocks

Valuing a company purely on its earnings does not always make sense. Sometimes the net value of its assets can be more useful.

Net asset value (NAV) per share shows the total asset value of a company minus its liabilities, divided by the number of shares in issue.


The price to NAV (P/NAV) helps compares the share price to the ‘per share’ value of its assets.

This shows the cost of a stock relative to the value of the company if its assets were broken up and sold.

This metric is often used to compare stocks in the real estate space or financial institutions such as insurers and banks which have significant physical or financial assets.

P/NAV is also often used as a metric to assess investment trusts.

A property company’s NAV would, for example, consist of the portfolio of properties it owns minus any debt.

Ten of the cheapest stocks by P:NAV

St. Modwen Properties (SMP) 358.6p

P/NAV: 0.8

The property investment and development business has enjoyed share price strength in recent weeks but remains at a 20% discount to its net asset value compared to the wider sector’s average discount of 16%.

This seems unjust given the potential for a continuing turnaround of the business under new chief executive Mark Allan and finance director Rob Hudson.

Investment bank Liberum rates the stock as a ‘buy’. It says: ‘St. Modwen’s significant 6,000-acre land bank provides a long-term pipeline of value creation potential. Its scale and regeneration focus also results in a limited pool of competitors for new schemes.’

Liberum believes the company could still realise value from its Nine Elms Square development, close to Battersea Power Station, despite a Chinese buyer pulling out of a deal in March.

Gulf Marine Services (GMS) 72.3p

P/NAV: 0.7

Maintenance vessel provider Gulf Marine Services (GMS) trades at a significant discount to the value of its fleet of vessels.

Improving market conditions and a reduction in its level of borrowing – net debt is expected to reduce from a peak of $375m to $335m by the end of the year – could act as a catalyst for the share price.

An asset-heavy business model has weighed on the company as its main industry – oil and gas – has suffered a slowdown leading to reduced utilisation.

The self-propelled, self-elevating support vessels provider undertakes work that is funded by a client’s operating expenditure budget – which is less vulnerable than capital expenditure spending. We’d argue it is therefore better positioned than several of its oil service peers.

Gulf Marine’s vessels are also cheaper to hire than the oil rigs which would otherwise be used to carry out maintenance. (TS/DC/JC/DS/LMJ)

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