Earlier this year, the flagship FTSE 100 index of London-listed shares hit a new all-time high.
It can be hard to remember that, though.
Swathes of FTSE 100 shares are trading on price-to-earnings (P/E) ratios of under 10. From Lloyds to BT, household names are selling at valuations that many classic value investors would regard as cheap. Legendary value investor Ben Graham would consider buying shares with P/E ratios as high as 13, depending on other elements of a company’s profile.
So I think the current market offers a great opportunity for investors including myself to try and build wealth, by scooping up bargain FTSE 100 shares on sale.
Like Graham, though, I do not only look at P/E ratios in making such investment decisions. After all, earnings can fall at any FTSE 100 company.
Instead, I would adopt the approach of Graham’s most famous disciple, Warren Buffett.
Hunting for long-term value
Buffett’s approach to investing is built around trying to identify a business that could prosper for decades to come.
So he looks for firms with a large potential customer market. Both BT and Lloyds fit that bill. In fact, I would say most FTSE 100 companies do. That is how they have been able to build the revenues and market capitalisation that has propelled them into the index of leading companies.
But Buffett thinks it is also important to find a company that can set itself apart from competitors that are going after the same market.
An example is Diageo. Lots of companies can distil alcoholic drinks. But by building a portfolio of premium brands such as Johnnie Walker, Diageo has given itself pricing power. That should help it generate sizeable profits even in a competitive market.
Buying at the right price
Part of building wealth is about owning the right assets. But another critical element is buying them at the right price.
As Buffett says, “Price is what you pay, value is what you get”. As an investor, I aim to build value by paying substantially less for shares than I think they are worth.
Of course, such bargains can be few and far between. After all, the stock market is stuffed full of investors like me who are also trying to buy shares in quality companies cheaply.
But I think the current valuation of many leading FTSE 100 shares offers an opportunity to do just that. I recognise the risks that a weak economy, high inflation and low consumer confidence could pose to profits at many large firms. But in some cases I think that is already more than reflected in the share price.
As a long-term investor, I also look beyond the short- to medium-term challenges and consider the possible future value a given business could create.
On that basis, many FTSE 100 valuations at the moment look like real bargains to me. By putting money into the London stock market right now, I hope to build wealth for the long term.
