A rare chance to build wealth with value stocks

Dr James Fox explains why the recent stock market correction may provide investors with an unusual opportunity to grow wealth using value stocks.

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Value stocks are those that trade at a discount versus their intrinsic or book value. And personally, I predominantly invest in value stocks. After all, some of the most successful investors of all time, including Warren Buffett, are value investors.

So why do I think now’s a rare chance to build wealth with value stocks? Well, it’s because some of my favourite ones just got a lot cheaper after the recent stock market correction.

Let’s take a closer look.

Value investing

Value investing revolves around finding stocks that trade at a discount versus their intrinsic or book value, and holding them until they’ve reached an optimal point for sale. This can involve holding them for a considerable period.

Buffett, one of the most famous value investors, often holds stocks for decades before reducing his position.

But the hard part can be finding these undervalued stocks. This requires research. We can use near-term metrics, such as the price-to-earnings ratio, or the EV-to-EBITDA metric. These metrics, when compared within a similar sector, provide us with an idea of relative valuation.

However, for a more precise idea of valuation, we can use a discounted cash flow (DCF) calculation. This involves using forecast cash flows and offsetting them against a discount rate — the time value of money.

It can be complex, but there are calculations online to help us with it.

That rare opportunity

Markets move up and down. We’ve seen plenty of volatility in recent years, with the Covid-19 pandemic and the disastrous mini-Budget.

But the most recent correction is a little different. While the pandemic and Truss’s budget presented a genuine threat to companies across the UK, this recent sell-off was about fear.

Investors were worried that banks were sitting on billions of unrealised bond losses. But, in reality, this was only an issue for Silicon Valley Bank where tech depositors were withdrawing their capital. It had to sell bonds at a loss rather than hold them through to maturity. Most banks hold the majority of bonds through to that end.

So I contend that now’s a good time to buy because the panic was unwarranted, and stock prices are yet to properly recover.

Value picks

My value picks are largely in the finance sector. That’s because it was hardest hit by the recent stock market correction.

One of my top picks is Barclays. DCF calculations suggest that the bank could be undervalued by as much as 74%. And with the share price pushing down, the dividend yield has now risen to 5.1%. That’s considerably higher than it was last summer.

Barclays has been undervalued for a while, according to DCF calculations. But with the share price down 17% over a month (9.2% over a year), the stock now looks even cheaper with DCF calculations.

Rather than unrealised bond losses, I’m actually more concerned about bad debt in this very high interest rate environment. But, thankfully, Bank of England interest rates are set to fall towards the second half of the year.

Over the medium term, we’re likely to see interest rates sit between 2% and 3%. That’s optimal for most banks as net interest margins remain elevated, but there’s likely to be a drop off in bad debt provisions. I’ve recently topped up on Barclays.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

James Fox has positions in Barclays Plc. The Motley Fool UK has recommended Barclays Plc. 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.

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