Sometimes we take for granted what surrounds us. Take the cheap shares in the FTSE 100 index, for example. Many blue-chip companies like Legal & General and Barclays are currently valued at the equivalent of under 10 years’ earnings.
But while such valuations may have come to seem like the norm over recent years, that does not mean they will necessarily last forever.
In fact, if I had spare cash to invest right now, I would happily use it to buy what I see as cheap shares.
How to look for value
Actually, I have been buying what I see as cheap shares already this year.
But while I bought into Legal & General, Barclays has not been on my shopping list.
Why?
In short, just because a share looks cheap it does not mean that it is necessarily good value. I am concerned at the risk that an economic downturn could lead to increased loan defaults, hurting earnings at banks like Barclays. So far there has been limited evidence of that happening. But I remain concerned that some UK bank shares may not be the bargains they seem.
An economic downturn is also a risk to profits at financial services firms like Legal & General, in fairness. But I continue to see Legal & General as a cheap share when weighing the risks against its strong brand, proven business model and high profitability.
Why I don’t try to time the market
Despite my enthusiasm, though, Legal & General shares have been getting cheaper. The share price is 6% lower than it was five years ago.
Rather than buying the shares this year, I could have waited for a while in the hope that I could buy them even cheaper.
But doing that I would be missing out on dividends along the way. With a dividend yield of more than 8%, I am being rewarded for owning the shares right now.
I also decided not to wait because I do not believe in market timing. Cheap shares could suddenly get more expensive with no prior warning.
As an investor, I see no point in trying to guess whether I think I will be able to buy a share cheaper in future by waiting.
Instead, I look at the value it offers me at any given moment and decide whether that is attractive enough for me to buy it.
Value and quality
Not all cheap shares are bargains.
Some, in fact, turn out to be value traps. They look cheap but are priced as they are for good reason. Maybe cash flows will no longer be enough to sustain the dividend, for example, or some new technology will undermine the business model.
So when looking for cheap shares to buy I also ask myself why a share is priced as it is.
Is it really a bargain, or have I missed something important that other investors have spotted?
