UK shares look like great value to me right now. Whether it’s building wealth or buying passive income, success in the stock market comes down to buying shares when they’re cheap.
This is how billionaire investor Warren Buffett has achieved so much success with his holding company Berkshire Hathaway. And it’s the approach I’m looking to follow in my Stocks and Shares ISA this month.
Investing in stocks
Buffett distinguishes between investing and speculating. Investing involves buying shares to profit from the underlying business over time, whereas speculating is buying stocks to benefit from short-term price increases.
I’m looking to follow Buffett’s example and build wealth by investing. There are two reasons for this – the first is it’s easier and the second is it has a better chance of being successful.
In the short term, the main force moving the stock market is investor sentiment. Over the long term however, a company’s share price typically corresponds to the performance of the underlying business.
Predicting how businesses like Unilever and Rolls-Royce will do over 20 years seems easier to me than working out how the market will feel about them in a month or two. That’s why Buffett and I think investing is easier than speculating.
In terms of success, the stock market can be prone to short-term fluctuations, but share prices have generally moved higher over the long term. That gives investing an advantage over speculating when it comes to returns.
Finding value
In general, I think London-listed shares are trading at relatively good prices at the moment. This is true compared to either international stocks or UK government bonds.
Right now, the FTSE 100 trades at a price-to-earnings (P/E) ratio of around 9, implying an earnings yield of 11%. By contrast, a 10-year UK government bond comes with a yield of 4.21%.
The extra risk means it’s natural for stocks to offer a bigger yield, but a spread of 669 basis points is quite wide. For context, the yield gap between the S&P 500 and a 10-year US government bond is around 61 basis points.
Equally, British shares trade at a significant discount to their US counterparts. The S&P 500’s earnings yield comes in just under 5%, around 600 basis points lower than the FTSE 100.
The reason for this is that the market is expecting much more from US equities in terms of growth. While I think that’s justifiable, I’m sceptical the divergence is going to be as wide as today’s prices imply.
The road to £1,000,000
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In terms of aiming for a million, the equation is fairly simple. If I can invest £20,000 a year (the amount I can protect from tax using a Stocks and Shares ISA) and average a 6% annual return, I’ll reach £1,000,000 in 25 years.
Is that achievable? I think it is – the average annual return over the last 20 years from the FTSE 100 has been 6.89%.
That timeframe includes the Global Financial Crisis, the UK’s exit from the European Union, and a pandemic. Whatever happens, I think it’s reasonable to expect UK shares to do well.
