Three ways to spot cheap shares and generous income payers

Whether you want to generate extra money to pay for school fees, fund next year’s big family holiday or you are saving up for another reason, investing is a great way to build your wealth. 

Certain investors will already know where they want to put their money, but others might be looking for inspiration. If you’re looking for ways to get going, here are three popular ways to screen the market for ideas. 

It’s important to do your own research and just because something is cheap or offers a high yield does not automatically make it a good investment. 

Low PE 

Source: AJ Bell, SharePad. PE = price to earnings ratio. Based on share price as of 23 August 2024 and forecast earnings per share for next year to be reported. 

One of the most widely used valuation metrics in the world of investing is to compare the ratio of a company’s earnings to its share price. This is called price-to-earnings ratio, often shortened to PE. 

The PE ratio is calculated by dividing the latest share price by forecast earnings per share. Analyst consensus forecasts can be found online. 

In general, if a stock has a PE ratio of 20 or more, it is either premium rated because of certain qualities within the business, or it is over-priced and expensive. A PE ratio between 10 and 20 can be fair value, although benchmark ratings can vary between different sectors. 

A ratio below 10 puts the stock in cheap territory. It is important to distinguish between companies that are lowly priced because of short-term problems or their sector is out of favour, compared to others that might be cheap because there is something fundamentally wrong with the business. 

These are only rules of thumb, and many investors rely on other metrics alongside the PE ratio to form a broader view on whether a stock is cheap, fair priced or expensive. 

Wizz Air has one of the lowest PE ratios among stocks in the UK’s FTSE 350 index. Its share price has fallen by more than 40% year-to-date amid broader market concerns about the airline sector and that has brought down the stock rating.  

Travellers have been leaving it until the last minute to book tickets across large parts of the airline sector and that has prompted operators to slash prices as they fight to get bums on seats. In doing so, earnings expectations have been pared back. 

Investors need to decide if Wizz Air’s shares, which trade on 5.8 times expected earnings for the next year, have now priced in all the bad news and are cheap, or whether they have further to fall. 

Low PEG 

Source: AJ Bell, SharePad. PEG = price to earnings to growth ratio. Based on share price as of 23 August 2024 and forecast earnings per share / EPS growth rate for next year to be reported. 

Certain investors like to consider a company’s earnings growth potential when weighing up whether to buy a share. A relevant valuation method is to use the price to earnings to growth ratio, or PEG. 

You first calculate the PE ratio (share price divided by forecast earnings per share) and then divide that figure by the forecast earnings growth rate. 

A low PEG indicates you’ll pay a low price for future earnings growth and a reading of 1 or below is considered cheap. Some market commentators believe the sweet spot for bagging a value investment is when the PEG ratio is somewhere between 0.6 and 0.8. This is subjective and not a golden rule to follow. 

Burberry trades on a PEG of 0.3, implying its shares are cheap versus the rate of earnings growth expected by analysts. The company has been going through a bad patch as sales haven’t been as good as forecast in Asia, leading to a change in management. 

The shares are trading at a 14-year low which is the market’s way of saying the company has lost its way. Contrarian investors might see this as an opportunity to buy into a well-known business on a cheap rating. Doing so would require faith in Burberry being able to get back on track.  

High yield 

Source: AJ Bell, SharePad. Based on share price as of 23 August 2024 and forecast dividend payments for next year to be reported. 

One of the key attractions for buying shares is collecting dividends. Not every company pays a dividend, but many do so on a regular basis, such as every three or six months. Therefore, the dividend yield on a stock can be of great interest to investors when researching the market for opportunities. 

The concept of a dividend yield is similar to the interest rate you get on cash held in a savings account. Your bank might offer an annual interest rate such as 3.5%, which means you will receive interest worth 3.5% of your savings each year. In this example, you would get £35 interest in a year on £1,000 worth of savings. 

A share offering the same payout as this bank account would yield 3.5%, meaning you would receive £35 in cash in a year for every £1,000 worth of its stock you hold. 

Where stocks differ to savings accounts is the ability to find companies that grow their dividend every year and many also have a yield much greater than the best rate offered on cash in the bank. 

In late August 2024, it was possible to open savings accounts paying as much as 5.2% interest, according to data from MoneySavingExpert. In contrast, 63 stocks in the FTSE 350 offered an even higher prospective dividend yield, based on calculations by SharePad using the share price at the time of writing and the consensus forecast in the market for dividends to be paid over the next year. 

It is important to note that dividends aren’t guaranteed to be paid, and companies can cut or withdraw them completely whenever they want. This does happen from time to time, and it is a key risk for investors to consider. 

ITV is among the stocks with a higher prospective dividend yield than best-buy cash savings accounts. It is yielding 6.2%, while also having a low PE ratio of 8.8 and a PEG ratio of 1. The business earns money from advertising, streaming platform subscriptions and licencing its content to third parties, creating a diverse source of income to help fund dividends as well as create new TV productions and support investment into its technology platforms.