A method I take advantage of to worth shares is the price-to-earnings (P/E) ratio. Through the use of a benchmark honest worth determine of 10, I can get a fast sanity examine if an organization’s probably undervalued. So once I noticed a FTSE 100 inventory with a P/E ratio of below 4, it naturally obtained me curious to dig deeper.

Current outcomes

The corporate’s Centrica (LSE:CNA). The inventory’s down 21% over the previous 12 months, hitting recent 52-week lows lower than a month again.

The proprietor of British Fuel has struggled to date this 12 months, with the H1 2024 outcomes exhibiting a pointy fall in revenue. Revenue earlier than tax dropped from £2.07bn a 12 months again to £1.1bn, with adjusted working revenue falling by an identical quantity from £2.08bn to £1.04bn.

The disappointing figures have been blamed on a number of components, together with “no repeat of one-off cost recoveries in British Gas Energy” for this era.

It additionally flagged a “more normalised external environment”, with decrease commodity costs. Nonetheless, when trying ahead the administration staff’s optimistic, particularly on account of “the investments [being made] in… data capabilities, product innovation and customer service”.

Understanding the ratio

The P/E ratio focuses on two components, the present earnings per share and the share price. With the drop in earnings, the earnings per share has fallen from 73p this time final 12 months to 25.1p. This acts to push up the P/E ratio. Nonetheless, the sharp dip within the share price over the identical interval has acted to partially offset this, retaining the ratio at a low stage.

Such a low ratio may point out a few issues to me. Firstly, it might be that the inventory genuinely is undervalued. From right here, if the earnings keep the identical, I’d anticipate the share price to rally to be able to get the ratio to a fairer worth within the coming couple of years. The extent of the positive aspects might be giant. If the earnings per share keep the identical and the inventory doubles in worth, the ratio would nonetheless solely be shut to eight!

The opposite implication is that individuals merely don’t need to personal the inventory. If sufficient traders assume that earnings will proceed to dip, the share price will preserve tumbling. Put one other means, the ratio could be low as a result of no worth patrons assume that it’s price investing.

The larger image

As a danger, I ought to word that the P/E ratio is only one snippet of data that I ought to use when interested by shopping for a inventory. But on this case, I do assume it presents me a very good perception.

The most recent outcomes don’t flag up something materials that I feel will probably be a long-term drawback for the corporate. The sector (utilities) is one which has a confirmed monitor file. It’s additionally a defensive play that I can use to try to shield the remainder of my portfolio from a inventory market crash.

Due to this fact, once I put all of this collectively, I’m significantly interested by shopping for some Centrica shares as a worth play for my portfolio.