The FTSE 100 is packed with cheap shares as stock market volatility persists. Plenty of these are brilliant bargains. However, many shares trading on low P/E ratios are investment traps waiting to catch investors out.
Here are two cheap stocks that I’m avoiding at all costs.
Mashed margins
Tesco’s (LSE: TSCO) profits are getting battered as it tries to compete with the discount chains on price. Operating profits at its retail division sank 10% between March and August. Costs are soaring, but the business can’t pass these on without losing customers.
Tesco remains determined to keep slashing prices even as margins evaporate too. Last week, it announced plans to slash prices on thousands of more products until next year.
The problem for Tesco is that it might be forced to keep cutting prices for the foreseeable future. The IMF has warned inflation in the UK will be higher than all eurozone countries at the end of 2023, except for Slovakia. In this environment, it faces a growing threat from the likes of Aldi and Lidl.
Moreover, it faces a prolonged period period of elevated product costs. Wheat, corn and sunflower oil prices, for example, have been rising again due to the war in Ukraine.
However, I think Tesco’s online operation could make the stock a winner as e-commerce steadily grows. I also like the company’s low forward P/E ratio of 9.6 times. But this cheap share carries more risk than I’m happy to accept.
Flying into trouble?
International Consolidated Airlines Group (LSE: IAG) shares also offer terrific value, on paper.
The British Airways owner isn’t expected to return to profit in 2022. But City analysts tip it to move back into the black next year. This leaves it trading on a P/E ratio of 5.4 times for then.
I like IAG because of the steps it’s taking to expand in the budget travel market. It owns Vueling and Aer Lingus and recently acquired a 20% stake in low-cost airline Air Europa. It’s rumoured that the Footsie firm could launch a fresh takeover bid for the Spanish business.
But this isn’t enough to encourage me to buy IAG shares. I’m primarily concerned about slumping demand for airline tickets as the cost-of-living crisis worsens.
Travel agent association ABTA said this week that 61% of Britons it surveyed plan to holiday abroad in 2022. However, a sizeable 36% also said they will take fewer holidays, and 28% are planning cheaper travel options.
This has the potential to subdue overall passenger numbers at IAG. It also threatens the profits it might make from its money-spinning transatlantic routes. At the same time, the airline industry faces a period of elevated fuel and staffing costs that further endanger profits.
It’s a double whammy that’s especially worrying, given the company’s huge debt pile. Net debt remained at an enormous €11bn as of June. IAG has terrific investment potential but it’s also vulnerable to further share price weakness.