LONDON -- The FTSE 100 has risen by more than 60% since it hit rock bottom in 2009, and bargains are getting harder to find, despite the market's recent losses.
I'm on the hunt for companies that still look cheap based on their long-term earnings potential. To help me hunt down these bargains, I'm using a special version of the price to earnings ratio called the PE10, which is one of my favorite tools for value investing.
The PE10 compares the current share price with average earnings per share for the last 10 years. This lets you see whether a company looks cheap compared to its long-term earnings.
Today, I'm going to take a look at the PE10 of Spanish banking giant Banco Santander .
Does Santander look cheap?
Santander is Spain's largest bank, but for many U.K. investors, its most attractive characteristic is its 11.9% dividend yield, which is the result of the bank having maintained its €0.60 per share payout for the last five years.
This high yield reflects the 58% decline in Santander's share price since 2010, but how have the bank's profits changed over that period? Let's take a look at Santander's price-to-earnings ratios:
Santander's PE10 of 5.8 is extremely low, and the bank's shares certainly look very cheap compared to its average earnings over the last 10 years. However, its trailing P/E of 23 tells a different story.
In 2012, Santander made provision for €18.8 billion of expected bad loan losses. Although the bank made a profit of €2.2 billion despite this, I'm concerned there could be more to come.
The problem is that Santander's €18.8 billion provision last year wasn't exceptional. Over the last four years, it has set aside €60 billion for bad loans. It's not clear to me whether there is light at the end of the tunnel, but clearly most big institutional investors don't think that Santander shares are worth the risk, even with an 11.9% prospective yield.
Is Santander a buy?
A double-digit dividend yield is nearly always a serious warning of underlying risk. Either the dividend will be cut, or the business paying the dividend will run into trouble.
Although Santander has remained very profitable since 2008, thanks mainly to its Latin American divisions, it isn't out of the woods yet. For me, Santander is still a little too risky, so I rate it as a hold.
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The article This P/E Suggests Banco Santander Is a Hold originally appeared on Fool.com.Roland does not own shares in any of the companies mentioned in this article. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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