Malcolm Wheatley

Cheap-looking shares, coupled to decent-looking businesses. What’s not to like?

It’s no secret that some of the FTSE 100’s biggest businesses are under the cosh right now. Which, for bargain hunters, can throw up some juicy pickings — under-valued shares, in short, that could be set to soar.

And that’s true for both income investors and those looking for capital upside, too.

Take mighty Tesco (LSE: TSCO ), for instance. This FTSE 100 stalwart has seen its share price fall by 25% over the past two years, with the biggest plunge in the wake of January’s profit warning. Over the same period, London’s flagship FTSE 100 index has climbed almost 10%, delivering a whopping 35% differential.

Yet Tesco’s annual dividend per share has continued its steady climb, putting the shares on a tasty 4.9% forward yield. Buying an income from Tesco has rarely been bettered.

Even so, Tesco isn’t one of my picks today. In looking for decent recovery plays for this article, I’ve discounted Tesco — even though I personally hold the shares, and have significantly increased my holding after January’s shock slump.

Screen

I began by running a screen on FTSE 100 companies, looking for businesses trading on a historic price-to-earnings (P/E) ratio that is at a 20% discount to the FTSE’s average of 9.85 — in other words, a P/E of 7.9 or so.

Straightaway, that eliminated some interesting looking prospects that didn’t quite make the 20% cut — Legal & General (LSE: LGEN ), for instance, currently trading on a P/E of 8.3. It also eliminated Tesco — the share might be beaten down, but it’s trading on a measly 7% discount to the FTSE’s average P/E.

Next, I eliminated very cyclical mining businesses. Their P/E’s might be low, but mining isn’t for me at the moment — especially when coupled to concerns over corporate governance issues.

So, it’s goodbye Rio Tinto (LSE: RIO ) on a P/E of 7.6, Eurasian Natural Resources (LSE: ENRC ) on a P/E of 7.4, and Vedanta (LSE: VED ) on a P/E of 5.9, for instance.

Finally, I kicked out businesses where the discount to the FTSE’s average P/E didn’t, in my view, provide an adequate margin of safety bearing in mind the industry risks they were facing. At which point, I bade farewell to Barclays (LSE: BARC ) and RSA Insurance Group (LSE: RSA ).

Last five standing

Which left me with five businesses with beaten-down share prices, but — to my mind, at least — decent prospects for recovery.

Interestingly, too, it turned out that I held all five. So what are they?