I recently searched the FTSE 100 for value shares and came up with international publisher Pearson (LSE: PSON), postal and delivery service operator Royal Mail Group (LSE: RMG) and building materials supplier Travis Perkins (LSE: TPK).
Cheap on the numbers
Compared to many other firms in the Footsie, all three firms are cheap based on the numbers as this chart shows:
| Share price | P/E ratio for 2016 | Dividend yield | price-to-book ratio | Gross gearing | |
| Pearson | 758p | 13.7 | 6.8% | 0.97 | 38% |
| Royal Mail | 496p | 12 | 4.6% | 1.11 | 14% |
| Travis Perkins | 1,398p | 11.4 | 3.3% | 1.22 | 23% |
Borrowings seem to be under control in each case, although it’s worth noting that Pearson and Travis Perkins have a lot of intangible assets. Therefore, the gross gearing figures and the price-to-book (P/E) values would be less impressive if we stripped those intangibles out.
Nevertheless, all three firms sport a low-looking P/E ratio and a substantial dividend yield. Overall, their value credentials measure up to scrutiny and each firm deserves further research and attention.
I know nothing
One of the guiding principles for many value investors is an acknowledgment that we really don’t know anything at all about a firm’s business, its prospects or the wider economy. We really are clueless as investors, and knowing that we don’t know anything puts us into a position of strength.
If we know we don’t know anything we can’t trip ourselves up by getting forecasts and predictions wrong. We don’t know which firms will go on to trade well or grow and we know it’s hopeless to try to guess. Therefore, we look for cheap shares. Firms with share prices beaten down by negative investor sentiment or simple lack of interest.
After all, a share price trading close to the firm’s underlying net asset value probably can’t fall much further, right? A low P/E rating and a high yield is a copper-bottomed indication of cracking value, right? Low gearing means manageable debts, right?
You know plenty
Not so fast. A lot can still go wrong. It’s possible for shares to value firms at a small fraction of their underlying asset value and that could happen if earnings fall off a cliff. With earnings gone, the attractions of a low P/E, high yield and low-looking debts could also be blown out of the water.
The trouble with the theory that we as investors know nothing is that we do actually know plenty. One of the things that I know is that all three of these businesses have a high degree of cyclicality in their operations, and cyclicality could conspire at some point down the line to create the impoverished-earnings scenario that I describe above.
If that happens, the shares will plummet — perhaps by as much as 80% or so. For example, look at Travis Perkins, trading around 1,398p today, but as low as 229p back in 2009. The shares could easily go there again.
But if you believe economies are about to turn up, right now could be a good time to take the plunge with Pearson, Royal Mail and Travis Perkins. Just remember what you’re getting yourself into and remain vigilant.