Rising interest rates are making savings accounts attractive. ButI think that buying cheap shares is the best way for me to build wealth in 2023.
As interest rates have risen in 2022, share prices have been falling. And the threat of a recession next year is a further headwind for stocks.
Nonetheless, I think that investing in shares trading at bargain prices will pay off over time. But what makes a stock cheap?
Warren Buffett
According to Warren Buffett, a stock is cheap when it trades below its intrinsic value. That means its share price is low compared to the cash the business will produce in the future.
As Charlie Munger points out, though, this isn’t always easy to figure out: “When you’re trying to determine something like intrinsic value and margin of safety and so on, there’s no one easy method that could be simply mechanically applied by, say, a computer and make anybody who could punch the buttons rich”.
Working out how much cash a company will produce in future is not as simple as finding the right number in a company’s accounts. But there are some numbers that can help.
There are some stocks that I think are cheap at today’s prices. And I’m looking to buy these for my portfolio in 2023.
Forterra
Top of my list is Forterra (LSE:FORT). I think that the UK brick manufacturing company’s future cash will offer a good return on its current share price.
Forterra shares trade at a price-to-earnings (P/E) ratio of around 7. That’s quite low – the global average is around 15. In general, a lower P/E ratio implies that a stock is cheaper. But this isn’t always the case.
A stock with a high P/E ratio might be cheap because its earnings will increase substantially in future. Equally, a stock with a low P/E ratio might be expensive if its earnings are going to fall.
In the case of Forterra, though, I think that the low P/E ratio is a sign the company’s shares are cheap. The company’s earnings might decline, but I think this is priced into the stock.
Future cash
With UK government bonds offering a yield between 3% and 4%, Forterra needs to be able to provide a return in excess of this to be cheap. I think that it can.
Forterra’s current share price is £1.87. That means it needs to average at least 7p per share in free cash to be considered cheap.
Over the last 10 years, Forterra has produced free cash flows below 7p per share once. On average, it has produced 17p per share.
That’s why I think Forterra shares are cheap at the moment. Even if future returns are lower than they are today, I’m still expecting a better return than I could get by buying government bonds.
