The Australian stock market is riding high, but finding cheap ASX shares with good value remains a challenge.
As the S&P/ASX 200 Index (ASX: XJO) scales new peaks, some investors are wondering where to find value plays.
Remember – price is what you pay, and value is what you get.
With a forward-looking market and sky-high valuations across many sectors, paying a reasonable price for growth is critical. Here's where Wilsons Advisory sees the ball landing.
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Cheap ASX shares in a roaring market
The ASX 200 has been propped up by a global equity market rally this year, with several index heavyweights posting double-digit returns.
While Australia's market has performed well, it has trailed behind the broader US market over the past year.
According to David Cassidy, head of investment strategy at Wilsons Advisory, the primary driver behind the ASX's gains has been price-to-earnings (PE) ratio expansion.
Cassidy says that over the past 12 months, the market multiple has risen from 14 times to over 18 times, limiting the number of cheap ASX shares on offer.
This is significantly above the ten-year average of 16 times and the twenty-year average of about 15. As such, it hasn't been corporate earnings growth driving the market.
The Australian equity market looks set to record zero earnings growth in CY24. CY25 earnings growth is expected to improve, but only to a still-moderate 5%. This compares to an index price gain over the past 12 months of 18%.
So the question is, where is the value?
While the broader market looks fully priced, Wilsons says that certain sectors and stocks may still offer value.
The first is healthcare:
In terms of sectors that look attractive, healthcare stands out as offering an attractive combination of a discounted multiple to its average valuation and attractive long-term growth. We remain overweight healthcare.
[CSL Ltd (ASX: CSL)] looks to offer a reasonable valuation with strong growth.
The next is within the energy sector. Among the resource sector, energy companies like Santos Ltd (ASX: STO) are trading at appealing valuations.
Cassidy says Santos offers "reasonable growth at an undemanding cheap valuation".
Mid-cap and small-cap stocks are the final domain Wilsons suggests investors scour for cheap ASX shares.
The firm says that ASX large-caps look "fully priced", with valuations on the big four banks in particular "looking stretched".
While there are reasonably priced options within the market, it is hard to escape the conclusion that the large cap end of the Australian market is, on average, fully priced. In our view, this suggests that an active approach to the Australian market is required.
What are the risks?
Finding cheap ASX shares means carefully selecting stocks with potential for growth that the market has not fully priced.
But hunting for investments on price or valuation multiples alone can lead to fool's gold.
Those familiar with the concept of a value trap will know that buying cheap stocks alone won't cut it. The key is to fill the other side of the equation – what you get in return for what you pay.
"A bird in the hand is worth two in the bush" type stuff. You have to get more in return for what you pay to have received value.
Foolish takeaway
Navigating the market for high-quality, cheap ASX shares requires a clear understanding of market conditions and individual stock opportunities.
But, as they say, buyer beware – price and/or multiples alone don't ascribe value. A comparison to growth is also needed.
