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

To determine if a stock is undervalued we are looking at the price to earning ratio (PE ratio). 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 to get a full picture of a stock there are several financial ratios you should use. Find out more here.

The PE ratio and the Aussie share market?

Morningstar is currently indicating that the market average PE ratio is approximately 16.95. This is a long way from where it was in July 2021 when the broader market PE was hovering at around 20.4. From there the XAO managed to rise a few per cent into mid-August before being range bound once again.

As we shared at the time, the Australian stock market has demonstrated an increased risk of a decline when the market average PE ratio is hovering between 21 and 23, so it was no surprise to see the market pull back into a ‘normal’ decline in 2022.

While many stocks were fully priced rather than undervalued in July 2021, even then it was possible to find stocks that indicated they were undervalued, at least in the short term. Given the current PE, and the way the market has pulled back into the January low and is now rising, the potential to find good opportunities has increased.

What is fascinating right now is how mining stocks generally trade 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. Currently, this has been turned on its head. Miners are trading with quite low PE ratios, and Financial stocks have been more in demand as the market looks for value over

growth.

In the current climate, where expectations are overshadowed by the current global conflicts including the war in Ukraine, and the expectation that the conflict could escalate, stock prices and their earnings can change quickly. What is confusing for investors is at times Value stocks can be Growth stocks. So it makes sense to focus on the merits of individual stocks on your watchlist that are suited to your portfolio criteria rather than trying to chase opinion.

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 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. If your plan states you are to trade the top 50 stocks that is your focus. 

When looking at some of the big stocks, consider BHP Group Limited (ASX:BHP). For example, currently BHP has PE ratio of 8.39 and a two-year average growth forecast of just 5.7%, but this is on the back of a historical 1 year earnings growth of 70.2%, however, currently forecasts indicate earnings may rise this year and fall back in 2023. But how reliable are forecasts right now? Still, current data is all you have, and of course the price chart will reveal the direction and indicate the right time to trade. 

As another example, previously we mentioned Healthcare stocks which also tend to trade with higher PE ratios. A good example in this sector is CSL Limited (ASX:CSL) with a current PE of 43.8 and a two-year earnings forecast of -1.5% on the back of 7.1%, which tends to indicate a greater risk to the downside. That said the share price has the potential to rise in coming weeks before you will be able to confirm whether this can be sustained. 

Here are some stocks that could be undervalued:

Eagers Automotive (ASX: APE)

At current prices, Morningstar data indicates there are a few stocks worth putting on the watch list, including Eagers Automotive Limited with a PE ratio of 12 compared to the market of 16.95 and sector average of 12.8. Although earnings are expected to be lower than the previous year, it is important to consider the historical one-year earnings at 128.9% above the prior period.

Eagers Automotive has operated in Car retailing, Truck retailing, and Property and Investments. The company has proven to generate profits from acquisitions. Eagers recently entered a non-binding agreement to sell its Bill Buckle Auto Group business and associated properties and is entering a joint venture to be the retail partner in the electric and hybrid market in Australia for BYD Australia and EVdirect.com. The stock is currently trading below $14 and if price holds above $13 in coming weeks a gain of at least 10% is probable.

RIO Tinto Limited (ASX: RIO)

RIO Tinto is a major explorer, producer and processor of Aluminium, Copper, Iron ore and minerals with a PE of just 6.69, however earnings are forecast to fall in 2022 before rising again in 2023. The two-year earnings forecast is currently around -20% on the back of one-year historical growth of 97%. Global tensions are making it difficult for the market to decide on the direction of this stock. Although in the short term the risk is to the downside from a fundamental and technical perspective, once the next low is confirmed there is potential for higher growth. Strong support exists at around $110, and RIO Tinto must trade above the 2008 high of $124.18 to continue to rise.

Reckon Limited (ASX: RKN)

Reckon is a small company with a market capitalisation of just $110 million, so may not suit all portfolios. The company solves accounting problems and provides businesses with accounting and legal software solutions and support. In 2020 Reckon Legal Group merged with a US company to develop a cloud-based platform for legal firms. RKN has a PE of 11.75 compared to the sector at 31.4. Morningstar does not currently provide a two-year forecast for earnings which combined with it’s lower liquidity means RKN is a highly speculative investment. So do further research. Price must be rising back above $1.06 to confirm the current low is in as this move could indicate the potential for a more significant rise in the share price.

Fortescue Metals Group Limited (ASX: FMG)

Fortescue Metals Group is a large iron ore miner and together with FFI, Fortescue’s 100 per cent renewable green energy and industry company, FMG is positioning itself at the forefront of the global renewable hydrogen industry. Fortescue’s PE is currently just 6.54 versus the sector at 13.05 and while this is historically very low, the current forecast indicates earnings will fall by 36%. Comparing previous earnings, the one-year historical is 98.6% growth on the prior year. Currently, risk is to the downside as the stock may decline back below $17 in the short term. A strong rise above $21 would indicate the risk has fallen and higher prices are likely in the second half of 2022.

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