LONDON — The FTSE 100 has risen by 25% over the last year, and many top shares are beginning to look quite expensive. I’m on the hunt for companies that still look cheap, based on their long-term earnings potential. To help me hunt down these bargains, I’m using a special version of the price-to-earnings ratio called the PE10, which is one of my favorite tools for value investing.
The PE10 compares the current share price with average earnings per share for the last 10 years. This lets you see whether a company looks cheap compared to its long-term earnings.
Today, I’m going to take a look at the PE10 of the U.K.’s fourth-largest supermarket chain, Wm. Morrison Supermarkets plc (LON:MRW).
Is Morrison a buy?
Morrison’s belated launch of an online service, in partnership with Ocado, has hit the headlines in recent weeks. However, the firm’s market share keeps slipping: It dropped to 11.6% during the 12 weeks to June 9, according to retail experts Kantar Worldpanel.
Wm. Morrison Supermarkets plc (LON:MRW) reported a 1.8% drop in like-for-like sales during the first quarter of its current fiscal year, following a 2.2% decline last year. However, it said it was on track to deliver growth, with a target of 100 M local convenience stores by the end of this year and online food operations due to begin in January 2014.
Morrison believes these initiatives will stem its declining sales and market share, but does it look cheap enough to buy? Let’s take a look at Morrison’s current P/E ratio and its PE10:
Wm. Morrison Supermarkets plc (LON:MRW) shares currently trade on a multiple of just 10 times last year’s earnings, which looks good value at first glance. However, it may be worth noting that the firm’s current share price gives it a PE10 of 16.9, compared to 14.8 for Tesco PLC (LON:TSCO) and 18.3 for J Sainsbury plc (LON:SBRY). To me, this suggests that the supermarket sector is fully priced at the moment, given the challenges it faces.
I’m concerned that Morrison’s growth opportunities may be limited. On the one hand, it’s smaller than Tesco, Sainsbury, and Asda, and it lacks the upmarket appeal of Waitrose. On the other hand, Wm. Morrison Supermarkets plc (LON:MRW) can’t compete with the aggressive discounting of Aldi and Lidl, whose market share continues to grow.