While recent market volatility has been disappointing for investors, every cloud has a silver lining.
The silver lining right now is the potential for investors to uncover cheap ASX shares following the volatility.
But as we have seen in the past, the window of opportunity is never open too long. As a result, I'm looking to buy cheap shares before the market rebounds and valuations return to normal again.
It's what legendary investor Warren Buffett has been doing for decades to great effect. He famously quipped:
Be fearful when others are greedy and greedy when others are fearful.
But if you want to be greedy, how do you find out if an ASX share is cheap or not? One way is the classic price-to-earnings (P/E) ratio.
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Price and earnings
I like to look at a company's P/E ratio to decide if it is cheap. This ratio is the result of dividing a company's share price by its earnings per share. As a guide, at present, the S&P 500 index on Wall Street trades with an average P/E ratio of 19.89.
It is admittedly a very simple valuation metric and not suitable for all ASX shares. For example, I wouldn't use it on miners like BHP Group Ltd (ASX: BHP), banks like Westpac Banking Corporation (ASX: WBC), or fledgling tech shares like Life360 Inc (ASX: 360). Instead, I would use valuation methods such as net asset value, book value, and discounted cash flow, respectively, for them.
However, for ASX shares where the P/E ratio is applicable, generally speaking, the lower the P/E ratio the better.
Accent Group Ltd (ASX: AX1) could be a great example right now. This footwear retailer's shares are currently trading at $1.69. And with Goldman Sachs forecasting earnings per share of 12 cents in FY 2023, this means that its shares trade at 14 times forward earnings.
Notice that I am looking at forward earnings here. This is an important distinction because an ASX share could look cheap based on last year's earnings. But if there's no chance of those earnings being repeated the following year, you could be falling into a value trap.
In light of this, I want to buy cheap ASX shares that face no obvious structural issues, are growing, and will continue to grow long into the future.
So, with Accent priced at 14 times forward earnings, which is lower than average, I would argue that this makes its shares cheap today. Especially given how Goldman Sachs is forecasting an earnings compound annual growth rate of 30.3% between FY 2022 and FY 2025.
Time will tell if it is the case, but I believe this is a cheap ASX share that offers a compelling risk/reward for investors over the medium to long term.
