It’s logical to assume that the higher the FTSE 100 index trades, the fewer stock market bargains exist within it. Fortunately for me, the FTSE 100 isn’t trading near any historical highs. It currently trades around 7,060, a far cry from the levels seen at the start of 2020 above 7,600 points. From this point of view, it gives me confidence that there are still companies out there that could rise in value.
Spotting a stock market bargain
With this top-down assumption that value does exist within the UK stock market, how do I find the bargains? I really have to think about what constitutes an undervalued share.
For me, a good place to start is by looking at historical returns. If a company or sector has returned lower than average returns over the past year or so, I can look deeper. Some will have a valid reason for underperforming, likely due to the pandemic. Extending this further, the pandemic might have damaged a business so much that it’s actually worth staying away from.
This ties in to my next point. Stock market bargains need to have some positive outlook to warrant an investment. One way I can differentiate is by looking at the price-to-earnings ratio. If a share price has fallen more than the relative fall in earnings, this could show that it’s undervalued.
I need to be careful though, as one financial ratio isn’t everything I need to make a decision. But it does allow me to slim down my areas to look at.
Where I’d consider investing right now
If I had £1,000 to invest today, I’d look at stock market bargains from areas including oil, travel, tourism and banking that have been battered but could bounce back. Consider two specific examples from the oil industry.
Royal Dutch Shell and BP are two examples that I’d think of buying. Over the past year, their share prices have declined 7% and 11% respectively. Their P/E ratios aren’t high, with Shell at 9 and BP around 21. BP has a higher ratio here due to earnings-per-share of 15.02p, which is a larger proportion of the share price.
Fundamentally, I think the outlook is bright for the industry for the coming year and beyond. I’d expect to see strong demand from aviation, retail fuel garages and other areas as travel increases. I appreciate that the extent of this rebound isn’t known at the moment, but I think this is why both are stock market bargains. If the future was certain, there wouldn’t be much of an opportunity for me to jump on.
The other industries mentioned also contain companies that tick the boxes to consider them stock market bargains. But in order to avoid exposing myself to too much risk, I’d allocate £250 to four stocks. This is because I don’t know how long it’ll take before the share price reflects a fairer value. By having money in several stocks, it should allow me to reduce this risk.
jonathansmith1 has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.