With most stocks down in 2022, many UK-listed companies look great value right now. That said, I reckon it pays to still be picky, even with some of the most established FTSE 100 shares.
When is ‘value’ actual value?
Since any market depends on people having different views on something, it’s no surprise that investors disagree on what actually constitutes ‘value’. For me, it means companies that look unfairly treated despite satisfying most/all of the following things:
- Revenue is growing
- Margins are improving
- Earnings aren’t especially volatile
- Dividends are going up
- The returns made from the money invested in the business are above average
Notice how I’ve not mentioned anything about share prices here. Sure, they’re important. But they’re not the be-all and end-all when it comes to making a decision.
Put another way, just because something is trading for pennies rather than pounds, or otherwise has fallen heavily, doesn’t mean it’s stonking value. Ascertaining this requires getting down and dirty with the latest company updates and/or annual report as well as looking at performance over time.
A FTSE 100 share that qualifies…
Now, I think there are plenty of FTSE 100 shares that meet most of if not all of the above criteria. Premium spirits purveyor Diageo springs to mind. With a price-to-earnings (P/E) ratio of 22, however, this is certainly not a ‘value’ stock in the traditional sense. Nor is it without risk, especially as purse strings are being tightened. No investment can boast this.
But I also reckon there are many top-tier stocks that don’t make the grade. Interestingly, some are very popular with retail investors.
…and those that don’t
Rolls-Royce is a great example. The engineering giant was the most bought stock at broker Hargreaves Lansdown last week. Surprising? Not really. Any blue-chip firm down 40% in 2022 alone intuitively feels like a great contrarian buy.
However, I feel Rolls-Royce fails to meet any of the above criteria. It also carries a huge amount of debt. Throw in the current economic headwinds (fewer people taking flights means less lucrative maintenance work on aircraft engines) and I struggle to feel enthusiastic about buying this stock today.
Vodafone is another company that demands a lot of investment by management for measly returns on that cash. Margins are average and revenue hasn’t gone anywhere in recent years. Debt has soared.
It’s not all bad. One thing in Vodafone’s favour is the 7% dividend yield. But this is only weakly covered by forecast earnings, which could mean a cut at some point. Consequently, I think there are better ‘bargain’ income stocks out there.
Buy the business
It goes without saying that the views expressed above — as well as my value checklist — are just my own. Nor am I saying that Rolls-Royce and Vodafone shares can’t ever generate profits for investors.
But as a Fool saving for the long term, I’m making a point of only buying shares where that value is good relative to the underlying business. Seen this way, an expensive share isn’t necessarily a poor investment; a dirt-cheap one isn’t necessarily a great one.
Diageo is down just 8% this year but I’d buy it in a heartbeat over its index peers. The probability of the latter being value traps feels just so much higher.
