4 Undervalued ASX Stocks in 2022

The Australian stock market is likely to be at an important turning point, and therefore now could be  an opportune time to look for good quality companies that may have been oversold or undervalued and may even lead the next rise.

Before we get into how to start looking for these companies it is important to emphasise that we would never suggest investors buy on fundamentals alone. Markets can take a dip, rise, turn and fall again. And so, with the current market and economic conditions, even the most skilled analysts draw on both technical analysis and fundamental analysis to make decisions. Considering both, it is a little too early to be certain that the All Ordinaries Index has reached its low.

What’s happening in the market now?

Although the technical analysis currently indicates that the market has fallen into a zone where a reversal is likely, a number of factors still remain that would support a further decline. Before you dive into the market, remember, a few days up on the market is not sufficient time to confirm the price rises are sustainable.

The good news is that the market is forward looking and often factors into current prices what may occur six to twelve months into the future. This could indicate that the worst is already priced into the market, particularly as many commentators are suggesting conditions that led to the sell-off could ease in 2023.

So, if the Australian market does confirm that the current rise is sustainable, which it is likely to do within weeks, I believe that we are likely to see a new all-time high before the year’s end or into early 2023. On the other hand, if sellers’ retake control, and I am confident we will know whether this is the case in August, then investors can expect a further fall on the All Ordinaries Index to around 6,300 points.
As the market may have turned a corner, investors can prepare their watchlists with potentially undervalued stocks and make sure they have good rules to buy when the individual stocks confirm the time is right.

What is the PE ratio and how can we use it to find undervalued stocks

A good place to start your search is to take a look at the top 50 stocks on the market and consider whether each company’s PE (Price Earnings Ratio) indicates the company could be undervalued. The PE is one way to find undervalued stocks, particularly when there has been a significant sell-off on the market, which is the case now as the market recorded a 17% fall since it’s all time high in early January. 

To explain, the PE ratio is used to measure the amount an investor needs to invest to receive one dollar of a company’s earnings. This can help investors evaluate if the share price is overvalued compared to others in the same sector or industry.

However, it is worth noting that these figures can change quickly and at times the data will lag what is actually occurring. So, to get a full picture of a stock there are several financial ratios you should use in conjunction with an understanding of how to read a price chart. Find out more about other financial ratios here.

The PE ratio and the Aussie share market

Morningstar is currently indicating that the market average PE ratio has continued to fall from above 20 in 2021 and is now sitting at approximately 14.6. To put this in perspective, the long-term average PE ratio for our market is around 15. With PE ratios returning to the long-term trend the risk of a further decline in our market is reduced. However, a company’s future earnings or earnings per share are also vitally important indicators and ought to be factored into your investment decisions.

While many stocks currently appear to be undervalued, it is important to highlight that in August companies will report their financial year results. This is important as we know that reporting season can be a great leveller and volatility generally increases significantly during this time, particularly if companies underperform or outperform forecasts.

With reporting due to start soon, expect the data on stocks that may currently appear undervalued could change as they will be reassessed by the market. This means they may or may not still be undervalued. Considering what is currently known, that the market has pulled back into the recent low and the reporting season is near, the potential to find good opportunities has increased.

PE ratios in different sectors

To more accurately assess the PE ratio of a company you have to compare it to that of its peers in the same sector. For example, compare big Australian banks to other big banks or possibly second tier banks. Or if you are considering buying a mining stock, say an iron ore miner, review the biggest quality miners in the sector first. Of course, your approach would be dictated by your portfolio criteria that guides you in determining your strategy and stock selection. If your plan states that you are to trade the top 50 stocks this must be your focus. Too many investors try to chase what is hot on chat forums or in the media rather than being strategic in their approach, which can be far more lucrative.

What is fascinating right now is how banks have fallen between 20% and 30% in price and as prices have fallen some bank PE ratios have fallen below the market average of 15. Morningstar indicates that ANZ and WBC’s PEs are currently below the market average, while CBA is at a premium to the market at 18. So, financial stocks have come back to around the longer-term trend.

Historically, we would expect mining stocks to trade mostly with high PE ratios and pay lower than market dividends as they are considered growth stocks, whereas Financials tend to have lower PE’s and higher dividends. In recent years, the opposite proved true. What is astounding to observe is how the big miners are currently trading with extremely low PE ratios, at around 5 to 6 and this is not the norm for these stocks.

These low PE ratios in our big miners could be an indication that the situation is fluid and prices may correct further, or these stocks have been significantly oversold. This is where investors need to understand how fundamentals can change and you need to keep a good eye on the longer-term price chart.

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Here are some stocks that could be undervalued:

Let’s take a look at a few ASX stocks in the top 50 with a PE ratio of less than 15. The top 50 is where you are more likely to find quality companies that have the potential to drive the next rise. Of the big four banks, ANZ and WBC have fallen the most in the recent decline and may provide the greatest potential for growth.

Australia & New Zealand Banking Group Ltd (ASX: ANZ)

ANZ’s market capitalisation has the bank ranked in fourth place relative to the other major banks CBA, NAB and WBC. Unbeknown to the market, when ANZ recently announced it had made an offer for MYOB it seems the Board had more than one iron in the fire. This week ANZ withdrew from the acquisition and announced a deal to takeover Suncorp (ASX:SUN) for $4.9 billion. Therefore, it has been an eventful couple of months for ANZ.

Comparing previous earnings, ANZ’s one-year historical earnings is 53.3% growth on the prior year. Prior to the opportunity to confirm that the recent low at $20.95 is the bottom it is important to be patient and allow high risk takers to try to pick the bottom and wait for ANZ’s share price to confirm a turn has occurred. The current trading halt may delay the earliest date to confirm that the next rise has begun. ANZ’s PE is currently around 10 and in line with the market average.

Rio Tinto Limited (ASX: RIO)

Rio Tinto’s PE is currently around 5.4 versus the sector at 9.9. Historically, this is extremely low for a miner. The current forecast indicates the two-year average earnings growth will fall by 4.2%. This is of course subject to changes in iron ore prices and demand from China. It is important to keep this in perspective. As the one-year historical earnings is 97.1% growth on the prior year, a slightly negative forecast for earnings growth means that earnings per share are very healthy. Currently though, risk is to the downside because of forecast demand from China. Also, technical analysis indicates that the stock may decline back below the November low of $87.28 in the short term. A strong rise above $108 would indicate the risk has fallen and higher prices are likely in the second half of 2022.

Fortescue Metals Group Limited (ASX: FMG)

Fortescue Metals Group is a large iron ore miner and together with FFI, Fortescue’s 100% renewable green energy and industry company, FMG is positioning itself at the forefront of the global renewable hydrogen industry. Fortescue’s PE is currently around 6 versus the sector at 9.9. While this is historically very low, the current forecast indicates that the two-year average earnings growth may fall by around 17.6%.
Comparing previous earnings, FMG’s one-year historical earnings is 98.6% growth on the prior year. Although currently, the risk is that FMG price continues to fall and trades back below $16.24 in the short term. It will likely need a strong rise above $20 to indicate the risk has fallen and higher prices are probable in the second half of 2022.

Westpac Banking Corporation (ASX: WBC)

Like ANZ, WBC was sold down heavily in the recent decline, having fallen by around 30% from its high in June 2021. WBC fell below a very important level at around $20 and currently it is too early to determine whether it has reached its low. We expect to have a better indication of its direction next month. WBC’s PE is currently around 13.5 which is in the normal range for a bank. Comparing previous earnings growth, the one-year historical earnings is 92.5% growth on the prior year. Currently the risk is that the stock may decline back below $18.80 in the short term. A strong rise above $22 could indicate the risk has fallen and higher prices are likely in the second half of 2022.

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