Buying cheap FTSE 100 stocks after the market crash could be a sound means of improving your long-term returns. In many cases they appear to trade on low valuations, and could benefit from a recovery for the index in the coming years.
Identifying undervalued FTSE 100 stocks may not be a straightforward task at the present time. However, by considering their earnings, dividends and assets, it may be possible to gauge whether they offer a sufficiently wide margin of safety to merit investment.
Earnings
In more normal economic times, many investors use the price-to-earnings (P/E) ratio to gauge whether a stock offers good value for money. For some FTSE 100 companies, this may still be relevant. Coronavirus and the containment measures being implemented by the government will cause the profitability of some companies to decline. But some other stocks are not experiencing a decline in their financial prospects.
Think about those businesses that are not being affected by coronavirus, or that could quickly return to similar levels of earnings as were posted prior to the outbreak. In these cases, using the P/E ratio could be a worthwhile means of gauging their appeal.
FTSE 100 dividend yields
Likewise, it may be possible to ascertain whether a stock offers good value for money from comparing its dividend yield to its historic average. For example, the FTSE 100 currently yields around 5.7%, which is significantly higher than its past average.
Some FTSE 100 stocks have announced that they will continue to pay dividends during the current economic crisis. In some cases, their yields are very attractive at the present time. That is due in part to weak investor sentiment towards the wider stock market.
However, some FTSE 100 companies have postponed or delayed their dividends. In some cases, there is a good chance they will be reinstated over the coming months. Using a prospective dividend yield may therefore be of some use in gauging whether they offer good value for money. That is especially important when low interest rates may gradually push income-seeking investors increasingly towards dividend stocks.
FTSE 100 asset values
Investors may wish to analyse a company’s asset base. That could be key when their earnings are likely to have fallen and dividends postponed due to coronavirus. For example, a stock that trades below its net asset value (calculated by subtracting total liabilities from total assets) could offer good value for money over the long term.
Of course, asset prices could realistically decline in the coming months if a recession occurs. As such, buying stocks with a margin of safety may be a worthwhile move. It could reduce your overall risks and allow you to generate high returns in the long run. Remember, valuations across the FTSE 100 are likely to return to their historic averages over the coming years.
