The price-to-earnings (P/E) ratio is the most used ratio in the world of stock market investing. It indicates the amount that investors are willing to pay for one pound of a company's earnings and is easily calculated by dividing the company's share price by its earnings per share. For example, if a company generates earnings per share of 50p, and its share price is 500p, the P/E ratio is 10, and indicates that investors are willing to pay 1,000p for a pound of earnings. The beauty of the ratio is that it allows investors to easily compare valuations between companies.
The lower the ratio, the cheaper the stock is, and many consider a P/E ratio of 15 to be an average valuation. However, today I'm looking at two FTSE 100 stocks that currently trade on P/E ratios less than 10.
Babcock International Group
Babcock International(LSE: BAB) is an engineering services company that provides bespoke services to the defence, energy, transport and emergency services sectors. The stock enjoyed a powerful run in the decade between 2004 and early 2014, rising from around 100p to almost 1,300p, however, after announcing a rights issue in early 2014 to buy Helicopter firm Avincis, the stock has struggled, declining almost 40%.
Shares in the engineering specialist currently trade on a low forward P/E ratio of just 9.7. Is that a bargain or are investors cautious for a reason?
The group released a trading statement this morning, advising the market that "the order book and bid pipeline of opportunities have remained stable, and continue to provide confidence in our ability to grow revenue as expected over the medium term." Revenue visibility has continued to improve, with 89% of revenue now in place for 2017/18.
With sales growth of 16% expected this year and a prospective dividend yield of 3.6% (covered 2.8 times) on offer, Babcock offers value in my view. The company has a very impressive dividend growth history, having increased its dividend every year since 2000, and with Neil Woodford having a sizeable shareholding in his Equity Income fund, I believe the business is worth a closer look.
Also trading on a P/E ratio of under 10 are shares in Aviva(LSE: AV), which look attractive at the current valuation, in my view. The insurance giant released a solid set of interim results in August, with operating profit rising 11%, and operating earnings per share increasing 15% to 25.8p. Chief Executive Mark Wilson triumphantly declared "Aviva is delivering."
The stock has strong dividend appeal in my opinion, as although Aviva cut its payout in FY2012, it has been increased for the last two years. Analysts expect dividend growth of 13.2% this year, taking the payout to 26.4p. That equates to a prospective yield of a formidable 5.2% at the current share price.
With City analysts forecasting FY2017 earnings of 54.4p, Aviva's forward P/E ratio of 9.3 looks good value relative to insurance peers Legal & General Group (P/E 10.3) and Prudential (P/E 12.8), and the FTSE 100 forward P/E ratio of 14.8.
Edward Sheldon owns shares in Aviva and Legal & General Group. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.