Stocks on the FTSE 100 make up a fair proportion of my portfolio. The index provides me with access to blue-chip companies, many of which are currently trading at low price-to-earnings (P/E) ratios compared to their US-listed peers. The index also has relatively large dividend yields — once again, larger than US counterparts.
So how can I use the method to build wealth and get rich?
Value investing
If I’m starting with nothing, or very little, it’s not going to happen overnight. Of course, I could put my disposable income into growth stocks, but these companies often fail.
Instead, I’d use a value investing approach like that of billionaire super-investor Warren Buffett and combine it with a compound returns strategy.
Buffett is one the best known investors worldwide. However, what many people don’t know is that he built 99% of his wealth after the age of 50.
The ‘Oracle of Omaha’ has a value-investing strategy that involves buying companies trading at a discount versus their book or intrinsic value. He holds these stocks for a long time, and sell them when they’ve actualised their potential.
Finding these discounted stocks requires me to do my research. I start by checking fundamental data. I can compare near-term metrics like the EV-to-EDITBA against peers. I can also run a discounted cash flow calculation. This helps me develop an idea of a fair value.
Using a value investing strategy, I can hope to achieve 10% in total annual returns — a combination of dividends and growth.
Compound returns
Compound returns is essentially the process of earning interest on my interest by reinvesting my dividends year after year. And the longer I leave it, the more money I’ll have in the long run.
So if I were to start with £1,000 and add £250 every month, increasing this contribution by 5% every year, after 20 years of using the above strategy, and achieving 10% total returns, I’d have £275,000.
That’s great, but the longer I repeat this strategy, the more money I’ll have.
If I were to continue reinvesting and contributing for 35 years, I’d have £1.59m. That’s huge. And it highlights the benefits of taking long positions and reinvesting overtime.
I’d say that’s enough to make me feel rich.
FTSE 100 picks
So I’m looking for stocks paying dividends and trading at a discount.
My first pick is Lloyds. The bank trades with a P/E of seven and has a forward dividend yield of 5.4%. That’s perfect for my strategy and I’d only need to see 4.6% share price growth to deliver my targeted 10% total returns.
UK banks are often cheaper than their overseas peers, but I don’t think they deserve to be. Lloyds trades at a considerable 55% discount to its fair value.
I’d also look at trusts. Greencoat UK Wind is a company I’m expecting to see on the FTSE 100 in a few years. The trust, which has £4.8bn in assets, provides a 5% dividend yield and has delivered consistent share price growth in recent years. While wind power can be temperamental, it’s among the cheapest forms of producing energy.
Both of these stocks are core parts of my portfolio.
