5 ASX shares with tiny P/E ratios (and why they're not as cheap as they look)

It pays to peel back a few layers before piling into the 'cheap' end of town. Learn from my mistakes.

| More on:
A woman peers through a bunch of recycled clothes on hangers and looks amazed.

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Who can turn their nose up at a bargain? It's almost innate to want to buy ASX shares when they are cheap, as is the desire to get a better deal on everyday purchases.

Unfortunately, all too often, this leads to investors scooping up companies that are trading on low price-to-earnings (P/E) ratios, convinced they're making a great investment. What can ensue in the following years is a company that sheds its sheepish clothing to reveal a wealth-eating wolf.

The humble P/E ratio can be a handy tool on the investing toolbelt, but it shouldn't be the only one.

Cheap doesn't always mean value

Legendary stockpicker Warren Buffett has said before, "Price is what you pay, value is what you get." In all its simplicity, it can be easy to misunderstand what is really being conveyed in this statement.

The point is the price is secondary. It's impossible to know whether you're getting a good deal until knowing what it is you are getting for the price. Only then can an informed decision be made on whether an investment might present good value for money.

What makes it even trickier is that future value can be different to historical value.

For example, imagine you're looking for a set of sheets. A set of Egyptian cotton sheets have been selling for $150 for the past year. Suddenly, the store calls you up, "Hey, we're taking orders for next year… $75 and they're yours. The only catch is there's a good chance they end up being polyester."

You think to yourself… I can go buy standard polyester sheets for $20. Why would I pay $75? If they turn out to be polyester, that's not really good value for my money.

Essentially, a lot of 'cheap' ASX shares can turn out to be $75 polyester sheets.

My favourite personal example of this is Vita Group Limited (ASX: VTG). Early into my investing journey, I came across this company that looked dependable — leasing out stores to Telstra Group Ltd (ASX: TLS) — safe as houses, I thought.

At the time, Vita Group was trading on a trailing P/E of around 6 times earnings. I was sold. How could an ASX share be so cheap?

Well, it turns out Vita wasn't so dependable. After Telstra bought back its stores, Vita wasn't left with much of a business.

Data by Trading View

Despite never trading for more than 11 times earnings between 2018 and 2020, the company's shares gradually became worth less and less.

From 'cheap' at $1.50, to not wanting to touch it at 15 cents.

Which ASX shares are suspiciously cheap?

Flicking through a list of Aussie companies currently available for earnings multiples under 10, there are five that raise some concerns.

  • Seven West Media Ltd (ASX: SWM) — 3.1 times earnings
  • Rural Funds Group (ASX: RFF) — 2.9 times earnings
  • Elders Ltd (ASX: ELD) — 7.8 times earnings
  • Magellan Financial Group Ltd (ASX: MFG) — 7.2 times earnings
  • Autosports Group Ltd (ASX: ASG) — 6.2 times earnings

Firstly, in my opinion, Seven West faces challenges with declining revenue from traditional media and increasing competition from Netflix Inc (NASDAQ: NFLX) and Walt Disney Co (NYSE: DIS) with the introduction of ad-supported tiers.

Furthermore, Rural Funds and Autosports could see their earnings reduce in coming years as profits normalise. Autosports has enjoyed above-average margins amid car supply shortages. Whereas Rural Funds has booked large profits from one-off gains in the past year.

Lastly, both Elders and Magellan are facing their own set of challenges. The Aussie agribusiness could see greater deterioration in business conditions if a drought grips the country. Meanwhile, Magellan is still trying to stem the outflows from its managed funds.

All of this is to say, it's worth taking a deeper look into a company before labelling it as a cheap ASX share. The abovementioned businesses might still represent value, but if they do, it won't be evident from the P/E ratio alone.

Motley Fool contributor Mitchell Lawler has positions in Elders. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Netflix and Walt Disney. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has recommended the following options: long January 2024 $145 calls on Walt Disney and short January 2024 $155 calls on Walt Disney. The Motley Fool Australia has positions in and has recommended Rural Funds Group and Telstra Group. The Motley Fool Australia has recommended Elders, Netflix, and Walt Disney. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on Opinions

A happy boy with his dad dabs like a hero while his father checks his phone.

1 market-beating, dividend-paying ASX stock that's a steal right now

I’m bullish about the long-term of this stock.

Read more »

A woman has a thoughtful look on her face as she studies a fan of Australian 20 dollar bills she is holding on one hand while he rest her other hand on her chin in thought.
Dividend Investing

Is the 9.2% dividend yield on Fortescue shares too tempting to pass up?

Is a 9.2% dividend yield too good to be true? Here's what I think.

Read more »

Cubes placed on a Notebook with the letters "ETF" which stands for "Exchange traded funds".

Why I'd still call the FANG+ ETF a buy

The US tech giants have been great performers.

Read more »

A man sleeps in a bed with white sheets while holding a teddy bear and a smile on his face.

This ASX stock is 13% of my portfolio and I don't lose a second of sleep over it

I feel very confident about the future of this business.

Read more »

Two people comparing and analysing material.

Are AGL or Pilbara Minerals shares a better buy?

Both of these companies could benefit from the changing energy landscape.

Read more »

A humanoid robot is pictured looking at a share price chart

'Defining trend this decade': 6 tips for buying AI stocks

Henry Fisher of CMC Invest discusses the rapidly rising artificial intelligence investment theme.

Read more »

Hands reaching high for a trophy with a sunset in the background.
Investing Strategies

3 reasons I'm still buying ASX stocks in July despite record prices

There are many reasons not to invest. A new high is not one of them.

Read more »

Smiling man working on his laptop.
Dividend Investing

Why I keep buying shares of this 5%-yielding ASX dividend stock

Here's why I bought shares of this blue-chip stock when they were yielding over 5%.

Read more »