Just two months ago the S&P/ASX 200 Index (ASX: XJO) was trading at a record high. Since then the spread of the coronavirus has caused significant damage to global economies and financial markets.
This of course led to shares being indiscriminately sold off by investors after sellers scrambled to the exits in their droves.
And while the market has recovered notably from its lows, it is still down materially from its February high.
This means that the majority of shares on the Australian share market are still trading at a fraction of what they were just two months ago.
I believe this selling has left many shares undervalued and has created a buying opportunity for investors. But how do you know which shares are cheap?
Identifying cheap shares.
Unfortunately, identifying cheap shares in the current environment isn't as easy as you might think.
Take for example online travel agent Webjet Limited (ASX: WEB). It is a high quality business which looked destined to be a market beater in the 2020s thanks to the incredible growth being exhibited by its WebBeds business.
But through no fault of its own, the coronavirus pandemic has hit its business incredibly hard and sent its shares to a multi-year low of $2.33 on Tuesday. This means they have fallen a whopping 86.4% from their 52-week high of $17.19.
From that, it would be easy to say that Webjet's shares must be incredibly cheap. When things return to normal Webjet's shares will recover and return to their former highs. Right?
Unfortunately, that may not be the case. A lot has changed over the last couple of months.
In FY 2019 Webjet delivered NPAT of $62.3 million and earnings per share of 48.6 cents. Based on its current share price this would mean a PE ratio of just 5x.
However, the company has added a significant number of shares to its registry this month via its equity raising.
At the start of the month Webjet returned from its trading halt after raising $231 million from institutional investors at a discount of $1.70 per new share. It is now undertaking a retail entitlement offer at the same price. Combined, Webjet expects to raise a total of $346 million.
I estimate that this will increase the total number of Webjet shares outstanding to just over 339.15 million. This compares to the 135.65 million shares it had outstanding previously.
If we take Webjet's NPAT of $62.3 million from FY 2019 and divide it by its 339.15 million shares, we get earnings per share of 18.3 cents. Which means Webjet's shares are trading at 13x FY 2019 earnings at present.
Whilst this remains cheap historically, given how weak travel markets are, it may be a few years before its profits rebound to that level again.
In fact, a recent note out of Morgan Stanley shows that its analysts estimate that Webjet will generate earnings per share of just 5 cents in FY 2021. Based on this, its shares are trading at 43x estimated FY 2021 earnings at present.
Which is far from cheap in my opinion.
Which shares are cheap?
I think shares that have been largely unaffected by the crisis but have still been caught up in the selling are the ones to look for until things become clearer.
Telstra Corporation Ltd (ASX: TLS) is a prime example of this. It is down 24% from its high despite reaffirming its guidance for FY 2020.
