The 10 cheapest UK 'value' shares being overlooked

Those who adopt a "glass half-empty" attitude may have viewed the FTSE 100's record high earlier this month as more of a warning sign than a cause for celebration.

There are, however, good reasons why private investors are more inclined to be looking down rather than up. The index has been on a remarkable winning streak, having gained 27% since its year low of 5,499 on 12 February.

The FTSE All-Share, which houses around 700 UK shares, has been on a similar run, up 25% over the same timescale.

One acid test that offers clues as to whether UK shares can continue soaring higher is valuations: when looking at the price/earnings (PE) ratio, the overall market is expensive against long-term averages, with a score of 22 versus 15.

Wide disparity

But according to Matt Hudson, who manages the Schroder UK Opportunities and Schroder UK Alpha Income funds, there is a wide disparity between the cheap and expensive stocks.

"If you believe that other [out-of-favour] sectors of the UK market - whether financial, or basic materials, or oil - can start to grow again, then this valuation point looks very attractive," he says.

With this in mind we asked SharePad, a data service for DIY investors, to screen the FTSE All-Share index for cheap shares that should be on value investors' radar.

Phil Oakley, an investment analyst at SharePad, screened the index for shares on a forecast p/e of less than 10. A "safety test" was then applied to eliminate shares that standout as obvious value traps. To pass the test each cheap share had to have an earnings before interest and tax (EBIT) yield of 10% or higher.

Each of the shares has forecast earnings per share growth of at least 5%Oakley explains: "The measure looks at a company's trading profits or EBIT relative to its enterprise value (EV). An EV is the market value of the total company, not just its equity or market cap.

"It takes into account the debts and pension fund deficit that the buyer of the whole company would have to take on. A high EBIT yield - more than 10% - [i.e. large profits, but a low valuation] could be a reassuring measure of cheapness along with a low PE."

To further sort the wheat from the chaff, Oakley ensured each share had forecast earnings per share growth of at least 5%. "Growing profits are a sign of health; [in this context] they could tell you that the shares have been overlooked and that too much pessimism is baked into the current share price," adds Oakley.

The table below showcases the top 10 cheap shares based on all the filters Oakley applied, ranked in order of the EBIT yield.

Brexit blues

For the majority, Brexit blues have pushed their shares onto a low valuation. Wizz Air Holdings and International Consolidated Airlines (the holding company of British Airways) have fallen 17% and 24% respectively over the past six months. Airlines have been among the hardest hit since June's Brexit vote, amid fears of a drop in travel demand.

Housebuilders were the other big losers, sending both share prices and valuations sharply lower. Our 10 cheap shares list is dominated by the sector, with five names featuring: Crest Nicholson, Bovis Homes Group, Bellway, Persimmon and Taylor Wimpey.

So far fears of sharp house price declines in London and the south east, which caused the initial sharp sell-off in housebuilders, have proved unfounded.

But the fact that shares are trading on low PE multiples and have not recouped their post-Brexit losses is an indication that the market is still sceptical as to whether the sector can continue delivering the high returns it has generated since 2010 (over which time it has been helped by favourable government policies and pent-up demand outweighing supply).

Next year, however, will arguably be the true test for the property market, once Article 50 is triggered and firms, particularly businesses in the financial sector, decide whether to relocate or stay in a post-Brexit London.

As ever, care needs to be taken when fishing for bargains, as investors risk catching a falling knife. While share screens are useful, further homework and due diligence needs to be carried out by private investors to assess whether a share is a genuine bargain or cheap for the wrong reasons.

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This article was originally published by our sister magazine Money Observer here

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.