Image source: Getty Images
When it comes to picking stocks, I often fall back on price-to-earnings (P/E) ratios to gauge market sentiment. They’re not perfect, but they can be a handy compass. A lot of investors see a high trailing P/E ratio and immediately assume a stock is overvalued.
But that isn’t always the case.
By comparing the trailing (ie past 12 months) P/E with the forward P/E, it’s possible to see how much earnings are expected to grow. If the two are equal, earnings are likely to remain flat. But if the forward number is lower, it suggests profits are forecast to rise.
Of course, there are caveats. Forward P/E ratios are based on analysts’ forecasts, which aren’t always accurate. If unexpected risks hit earnings, the gap between trailing and forward P/E can close for the wrong reasons — with the share price falling rather than earnings improving.
Still, I like to use this method as a starting point. And right now, I think I’ve found two cheap shares that could stage a decent recovery in the coming year.
Taylor Wimpey
Taylor Wimpey (LSE: TW) has been in the doldrums. The housebuilder’s share price has slumped 40% over the past 12 months as stubborn inflation keeps the UK housing market under pressure. Earnings growth has plunged by 65% in the past year, leaving it with wafer-thin margins and a disappointing 1.97% return on equity (ROE).
Yet it’s not all doom and gloom. Revenue actually grew 4.2% over the past 12 months, and analysts are expecting earnings to bounce back. That explains why the stock currently trades on a lofty trailing P/E of 40, but a forward P/E of just 11.5.
Backing this up is a low price-to-book (P/B) ratio of 0.81, which suggests the market is pricing the company below the value of its assets. Of course, without a market recovery, the share price might continue to tank.
But with a 9.59% dividend yield, it wouldn’t be a complete loss. For me, Taylor Wimpey looks like a classic turnaround candidate with income appeal built in.
Tate & Lyle
Tate & Lyle (LSE: TATE) has also struggled, dropping 20% over the past year. In June, UBS slapped a Neutral rating on the stock with a 590p price target, citing a lack of volume growth and limited prospects.
This followed underwhelming results in May, when the company warned full-year revenue growth would be capped at 4% due to rising tariff-related costs between the US and China.
That explains the valuation mismatch: Tate & Lyle’s trailing P/E stands at 35, but its forward P/E is just 11.1. The business enjoys strong cash flow, a solid balance sheet and offers a respectable dividend yield of 3.67%.
The big sticking point here is trade tariffs. They’ve weighed heavily on profits, but with mounting pressure on the US to ease tariffs, there’s a chance the company could benefit from a significant rebound if conditions improve.
Final thoughts
As a holder of Taylor Wimpey, I’m biased — but I do believe the stock looks undervalued, with the potential to deliver both growth and income. Tate & Lyle, meanwhile, is another intriguing option, although its future hinges heavily on tariff negotiations.
Both are cheap shares in my book, and both could reward patient investors considering them now if forecasts play out.
