Here's where to find the cheapest stocks on the market
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Associate Editor
David Stevenson Oct 16, 2009
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It's getting much harder to find good value stocks nowadays.
Since the FTSE 100 bottomed in early March, it's recovered by a staggering 50%. Most UK shares have been carried along by the market tide, and many have done much better than the benchmark index, regardless of the 'fundamentals'. If many of these stocks really were good value seven months ago, they certainly aren't now.
But one sector's hardly risen at all. And it's now looking very cheap indeed...
Don't be fooled by 'better than expected' profits
Shares may have soared, but there are only tentative signs of things actually improving in the real world. Right now there's a lot of brouhaha, particularly in the States, over companies reporting 'better than expected' profits.
That's hardly surprising, as many of the earnings forecasts had been slashed too hard by analysts who were fearful of being caught out again after last year's profit slump. Yet markets have kept going up, to the point where most shares simply aren't cheap any more – and many have become downright expensive.
So for value seekers (if you want to know more about value investing, my colleague Tim Bennett wrote on this in MoneyWeek magazine recently: How best to invest in the Asian market) it's not an easy time. (if you're not already a subscriber, claim your first three issues free here.)
We've spotlighted areas that are still cheap, such as the big drug stocks which we mentioned last week: Snap up drug stocks while they're still cheap.
One of the last cheap sectors in the stock market
Not many others are left. But one sector sticks out like a sore thumb – 'non-life' insurance.
Non-life insurance does what it says on the tin: it covers all types of risks bar death. A non-life insurer makes profits when its expenses (the cost of settling claims, plus admin expenses) are lower than the total premiums it receives. Divide the former by the latter and you get the 'combined ratio'. And even if this is above 100% (i.e. the firm's spending more than its premium income) it can still make an overall profit if its investment income - the money made on the cash it has built up from prior-year premiums and on unsettled claims, which can take years to agree – is greater than its underwriting losses.
Because non-life insurers must provide for settling these claims at some stage in the future, they need to hold liquid, low-risk assets. Which makes them, in a nutshell, rather boring.
So they've been more or less bottom of the list for investors looking for high-octane market action. To date, the market has been driven by the "dash for trash", as people have piled into cyclicals which depend heavily on how economies are doing. Indeed, non-lifes have been so deeply out of favour, that they've undershot the overall market by 25% on average since early March. But for the contrarian buyer, this is a big plus point, as many of these stocks are now relatively very cheap.
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Four cheap non-life insurers
Top dog in the sector is RSA (LSE: RSA) – as in Royal Sun Alliance – with a market cap of more than £4.5bn. At 136p it's on a forecast p/e for next year of 9.6, a price/net asset ratio of 1.2 (i.e. the price is just 20% higher than the assets), and a 6% yield.
And there's even better value among some of the smaller 're-insurers', who provide insurance to other insurance companies by taking on some of their risks. Here are three of the cheapest.
Amlin (LSE: AML), the new sponsor of rugby union's European Challenge Cup, has a market worth of £1.9bn. At 386p, the current year multiple is 7.6, which is forecast to drop to around seven in 2010, while the 2009 yield is 4.8% and expected to climb to 5.2% for next year.
And two more, both with £600m-ish market caps - Beazley (LSE: BEZ) at 110.5p is selling on a 7.3 p/e, and a price/book ratio of 0.95. Analysts expect the p/e to drop to just 5.4 for 2010. Meanwhile, the prospective yield is a tasty 6.2% for this year, and 6.7% for 2010.
And at 211p, Brit Insurance (LSE: BRE), sponsor of the Brit Oval and of England's cricketers for four years from 2010, is on a current year multiple of ten, expected to fall to just over six in 2010. The price/book ratio is just 0.8, and the yield is over 7%.
This is great value – as good as you'll find anywhere.
Is Sainsbury's still a hold?
Finally, a footnote on J Sainsbury. My advice two weeks ago (Why you should buy shares in Sainsbury's) to pick up some stock in the underperforming - and now cheap - grocer at around 320p didn't look too clever straightaway. Although the company is doing well, the boss cautioned about a "challenging consumer environment", and the shares were marked down 3%.
But in stock markets, things can change very fast. Two years ago the Qatari Investment Authority made a £10.6bn bid for Sainsbury's. The share price fall since then has chopped the company's stock market value by some 40%. But yesterday there was much frenzied chatter about the QIA slapping another bid on the table, having supposedly offered the Sainsbury family 420p a shot for its stake.
So far, there's just been a great deal of rumour and counter-rumour. The share price bounced up to 370p but came back a bit to close at 342.5p – although that was still up 11% on the day.
But I reckon there's no smoke without fire. And while takeover talk doesn't rank among my reasons for buying stocks, there's no doubt that Sainsbury is cheap and that it's now 'in play', i.e. bidders could well be circling. So if you believe that buying 'value' stocks, i.e. those that are cheap when judged on the likes of cash flow, p/e and yield, generally works out well in the end, it's worth holding on for now. Bidders look for good value too.
Though should the stock bounce back fast to near 400p, a 25% profit in less than 25 days shouldn't be sneezed at and I'd be tempted to take it. Watch this space.
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