The UK index is a great place to look for value stocks. These trade at a discount versus their intrinsic or book value. And the defining characteristic here is that the current price is lower than fundamental metrics (earnings, book value, or cash flow) suggests.
What is value investing?
The strategy, known as value investing, has outperformed all major indices in recent decades. One of the most famous followers of the approach is Warren Buffett — perhaps the most successful investor of the post-war era. He’s amassed a fortune worth over $100bn as a value investor over the past six decades.
It’s all about finding value where other investors aren’t necessarily seeing it. And it can require plenty of research.
To find undervalued stocks, I can use simple, near-term metrics such as the price-to-earnings (P/E) ratio, or enterprise value-to-EBITDA. But there are the more complex metrics, such as the discounted cash flow (DCF) model.
The strategy also generally involves holding onto stocks for a long period. After all, it could take decades for a company to reach its value potential. So investing in value stocks can be very rewarding.
But what are the stocks to pick? Let’s take a look at three of my favourites.
- Price-to-earnings (P/E): 5.7
- Discounted cash flow: Undervalued by as much as 33%
Vistry Group is my No 1 housebuilding stock and I’ve been topping up. I’m expecting to see considerable upwards movement in the sector in the coming months and years as the macroeconomic picture becomes less challenging.
But Vistry is also something of a safer choice. It has a partnerships business that builds affordable housing for local authorities — this provides resilience against fluctuations in the private market. Private market data is improving, but another interest rate rise isn’t what the sector needed.
And a discounted cash flow analysis suggests the stock is undervalued by as much as 33%. That’s ideal. Buffett is known to look for a margin of safety around 30%, or even higher.
- P/E: Five
- Discounted cash flow: Undervalued by as much as 73%
Barclays is among the most undervalued stocks on the FTSE 100. It’s unloved, unpopular, but it’s a solid institution with a variety of income sources.
Some analysts are suggesting the current high interest rate environment is great for banks. In fact, some are saying this is best it’s going to get because net interest income is soaring.
But I disagree. Impairment charges are high — bad debt provisions increased to £524m from £141m in Q1. This remains a concern while interest rates are this high. Instead, I’m buying for the medium term, when interest rates are closer to 2% or 3%.
- P/E: Eight
- Discounted cash flow: undervalued by as much as 53%
Airtel Africa is a little different to the other companies on this list. It’s one with huge organic growth potential, but it’s also undervalued.
Part of its valuation reflects the challenges of doing business on the African continent — primarily political risk. A telecommunications and mobile money company operating in Europe and North America would likely have a much higher valuation.
However, it’s a hugely promising sector in a part of the world that’s seeing a massive increase in mobile phone usage. Over the past year, Airtel saw a 20.4% increase in mobile money customers to 31.5m.