Will the stock market recover? It’s sure to, some day, isn’t it? And if it’s soon, today’s dirt cheap shares could quickly become history.
So, let’s think about how to pick five cheap FTSE 100 shares now, from different sectors.
Start simple
I’m going to start simple. I’ll search for the the stock with the lowest forecast price-to-earnings (P/E) ratio in each sector, and pull out five from the results.
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In fact, I’d check a lot more things before I’d buy. But my search for cheap shares has to start somewhere.
| Sector | Stock | P/E | Dividend | 12-month change | 5-year change |
| Banks | Barclays | 5.1 | 4.8% | +0.9% | -7.5% |
| House builders | Berkeley Group Holdings | 11.9 | 3.1% | +25% | +13% |
| Life insurance | St James’s Place | 11.9 | 6.4% | -23% | -28% |
| Pharmaceuticals | GSK | 11.2 | 3.6% | +15% | -1.7% |
| Mining | Rio Tinto | 9.2 | 6.4% | +9.2% | +31% |
Diversification
If I buy all five of these, I’d get some fair diversification. But I’d get something else too.
What I’d have is a portfolio with an average P/E of 9.9, and an average dividend yield of 4.9%. And I don’t think that would be too shabby at all.
In fact, if I took the risk of not digging any deeper and, say, spread a year’s Stocks and Shares ISA allowance across them, I suspect I could come back in 10 or 20 years and be happy with the outcome.
But, using this as a starting point, I think I could do better.
Dirt cheap?
Firstly, this simple screening has thrown up three stocks that I rate as the best in their sectors.
Barclays, on such a low valuation, really does look dirt cheap to me. Banks face a fair bit of risk in the next year or so. And Barclays is exposed to US banking too, and the stock market looks a bit hot there.
But Barclays is on my want list, for sure.
GSK and Rio Tinto? They both look very good value to me. There’s cyclic mining risk, and worries about Chinese demand.
And GSK’s valuation isn’t screaming cheap, but it’s well below something like AstraZeneca, on a P/E of 30.
Dig deeper
The other two? Neither would be my top sector pick. But seeing them here inspires me to look closer at their rivals, and I like what I see.
In the insurance sector, which faces similar risks to banks, Aviva or Legal & General would be my pick. They’re on slightly higher valuations, but offer better dividend yields, at 8% and 8.7%, respectively.
And that leaves house builders, where Taylor Wimpey would be my FTSE 100 choice. Valuations in the sector might not look dirt cheap. But in a down year, when earnings are dropping, I see good value. It might take time to fully recover, though.
Stock screening
I reckon the real benefit of screening stocks based on a specific measure like this is that it helps me cut through the hundreds of stocks out there.
It’s not the end of my search for cheap shares, but I’d say it makes a good start.
