How to tell if a share is cheap

Working out whether a market is cheap is straightforward, but for individual shares, it is less easy. Here, Phil Oakley offers a solution.

There is no right way to value a stock. Most measures have their pros and cons. But one of the most popular is the price/earnings (p/e) ratio. This takes the share price and divides it by earnings per share (EPS). The lower the p/e, the less you are paying per £1 of earnings. It's quick and easy, which may explain its popularity. But how can you get the best out of it?

Most people work it out by using the latest reported EPS figure, or one based on analysts' forecasts for the year ahead. The trouble is, lots of companies' earnings bounce up and down with the economic cycle (cyclical' stocks, such as miners and housebuilders, in particular). Analysts' forecasts are often on the optimistic side because they tend simply to extrapolate the most recent trend for the years ahead. So is there a better way to do this?

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Barratt Dev£199.5mLSE: BDEV335.8p£3,290m16.496.06%
Persimmon£267.7mLSE: PSN1,152p£3,500m13.077.65%
Bellway£129.6mLSE: BWY1,391p£1,694m13.077.65%

Phil spent 13 years as an investment analyst for both stockbroking and fund management companies.

 

After graduating with a MSc in International Banking, Economics & Finance from Liverpool Business School in 1996, Phil went to work for BWD Rensburg, a Liverpool based investment manager. In 2001, he joined ABN AMRO as a transport analyst. After a brief spell as a food retail analyst, he spent five years with ABN's very successful UK Smaller Companies team where he covered engineering, transport and support services stocks.

 

In 2007, Phil joined Halbis Capital Management as a European equities analyst. He began writing for MoneyWeek in 2010.