The stock market’s been rampaging over the last eight months. With inflation steadily falling, investor sentiment’s improved drastically compared to early 2022. And, subsequently, UK shares across the board have been marching upward.
Since October 2023, the FTSE 250‘s surged more than 25%, including dividends! That puts it firmly back in bull market territory. Similarly, the flagship FTSE 100‘s also up by double-digits, with the FTSE All-Share tagging along for the ride.
Yet despite this stellar surge of growth, many UK shares are still trading well below their pre-inflation prices. So supposing the recent stock market momentum continues, it may not be long before these cheap shares start delivering fantastic results.
Capitalising on slashed prices
2022 was the first time in over a decade investors had to endure a prolonged slide in valuations. That’s because such events are actually pretty rare. There are always buying opportunities to take advantage of. But having such a wide range of options available all at the same time is exceptional.
However, not all of these ‘cheap’ stocks are actually bargains. Some may never recover to their former highs. Therefore, simply snapping up sold-off stocks could likely end up destroying wealth rather than creating it.
Instead, investors still need to exercise discipline and diligence when selecting companies for a portfolio. This is especially true when examining smaller enterprises.
A downturn in the market may only be a temporary headwind, but it could still be a permanent threat if a business doesn’t have the financial resources to see it through the storm. Similarly, a company that hasn’t been able to protect itself with a competitive moat could see its performance wither as other firms steal market share.
With that in mind, investors need to look beyond the stock market climate when determining why a stock has taken a tumble. That way, it becomes far easier to identify traps.
A bargain stock to buy today?
Among the cheapest stocks within the FTSE 100, Centrica (LSE:CNA) currently stands out. The energy and utilities business has hugely benefited from higher energy prices. Yet its price-to-earnings (P/E) ratio sits at just 2.0 compared to the market average of 10. That certainly sounds like a massive bargain on the surface, but is this a trap?
It’s important to highlight that 2023 saw a lot of non-repeating sources of profit for this enterprise. As a result, the P/E ratio’s currently biased downward. Therefore, using the forward P/E ratio is more appropriate and this increases the metric to 7.0. That’s still looking relatively cheap, but it’s clear this business isn’t the stellar bargain suggested.
In the short term, things are looking up for this enterprise. And it seems the majority of analysts following the stock are recommending to buy with an average 12-month price target of 170p – about 27% higher than today’s price. But in the long run, there may be some greater uncertainty.
A lot of British households are transitioning from gas boilers to heat pumps. This is something Centrica’s involved in, but it remains a relatively small part of its business. And that’s created a potential opening for smaller competitors to swoop in and carve out a lump of market share in the long term.
This post was originally published on Motley Fool
