I’ve been hunting through the FTSE 100 for potential bargain buys. Today, I’m going to take a closer look at three of the stocks I’ve found. I want to know why they’re cheap, and what could go wrong.
Postal profits uncertain
Shares of Royal Mail (LSE: RMG) surged to a post-IPO high of 549p earlier this year, before shifting into reverse. The UK postal operator is now worth 16% less than it was in July.
I’d argue that Royal Mail shares now look fairly cheap. Earnings forecasts have been upgraded following last month’s results. Royal Mail now trades on a 2016/17 forecast P/E of 11.4, with a prospective dividend yield of 5%. This payout should be well covered by earnings.
One downside is that Royal Mail’s adjusted earnings are expected to fall slightly this year, for the second year running. The group is also mid-way through the costly challenge of modernising its operations. It must win a larger share of the UK parcel market to offset the ongoing decline in letter volumes.
A final risk is that proposals to shut the firm’s final salary pension scheme have been met with threats of strike action. The group hopes to find a resolution by the end of March.
In my opinion, Royal Mail’s unique advantages should make it a profitable long-term investment. But skilled management will be required to generate rising profits.
Are housebuilders too cheap to ignore?
York-based housebuilder Persimmon (LSE: PSN) trades a forecast P/E of 9, and offers a cash-backed dividend yield of 6.4%. The group’s share price hasn’t fully recovered from the Brexit sell-off, despite City analysts upgrading their earnings forecasts every month since August.
Full-year earnings are now expected to be 192.1p per share, up from 187.6p per share in June. On this basis, Persimmon looks cheap — the shares are trading on a lower P/E ratio than before the referendum.
The risk is the housing market could still slump, triggering a dramatic fall in future profits. If this happens, Persimmon’s net asset value of 760p per share will provide very little protection for shareholders, given the current share price of 1,690p.
If you’re thinking about investing, I believe you need to take a view on the property market first.
This could be the turning point
Shares of Anglo-Asian bank HSBC Holdings (LSE: HSBA) have risen by 40% over the last six months. The end result is that HSBC’s share price is back where it was two years ago.
However, the outlook has improved significantly for shareholders. HSBC’s CET1 ratio, a key regulatory measure, has increased from 11.9% at the end of 2015 to 13.9% at the end of the third quarter.
The bank’s profits are now expected to rise next year, after three years of declines. Analysts expect earnings per share growth of 6% in 2017, giving HSBC stock a forecast P/E of 13. HSBC also offers one of the highest dividend yields in the financial sector, at 6.4%.
The risk is that banking investors who rely on City forecasts for guidance have been disappointed many times before. Downgrades have been more common than upgrades over the last few years.
However, the weaker pound has boosted the value of HSBC’s dollar earnings, and trading does seem to have stabilised. Further gains are possible.