Over the last two years, inflation wreaked havoc on companies of all sizes, including those in the FTSE 100. With input costs going up and consumer spending going down, achieving growth has been challenging, to say the least. And the situation has only been made worse by rising interest rates driving up the cost of capital.
However, the Bank of England’s (BoE) efforts seem to be bearing fruit. Looking at the Consumer Price Index (CPI), inflation has cooled down significantly and is inching closer to the ideal range of 2% to 3%.
Providing that no more spanners are thrown into the works, I wouldn’t be surprised to see inflation reach the BoE’s targets in 2024. If that’s the case, interest rate cuts may be coming. And while I doubt they’ll be dropping near 0% again, the reduction in cost of capital is terrific news for investors.
So, what’s the best way to capitalise on this potential reality even with just £1,000 at hand? Let’s take a look.
What’s the goal?
Falling interest rates and inflation are good news for stock prices for both income- and growth-oriented FTSE 100 businesses. So, which one should investors focus on? The answer ultimately depends on an individual, their risk tolerance, and investment objectives.
Growth shares offer the potential for explosive long-term returns. But this often comes at the cost of heightened volatility that not all investors are willing to stomach. Income shares are typically more stable, but the returns might be insufficient for someone comfortable with taking on more risk.
Undervalued companies will outperform
Regardless of whether an investor is targeting growth or dividends, the stocks most likely to deliver stellar returns are the ones that continue to trade at a significant discount. Apart from the boost provided from rising discounted cash flow model valuations, improving economic conditions are good for business.
Therefore, as consumer spending returns, the pressure on a firm’s cash flow could be alleviated. This not only helps manage any outstanding debts but also bolsters cash flow to fuel reinvestment. What’s more, if interest rates are eventually cut, the affordability of new loans could improve, giving management teams more financial flexibility to pursue new projects.
Needless to say, if a dirt cheap company suddenly starts delivering rapid growth, then investors are likely to start taking notice. This could be the spark that sends these shares flying, rewarding investors who bought in near the bottom with potentially big returns.
Of course, that’s easier said than done. FTSE 100 companies rarely fly under the radar due to the popularity of the UK’s flagship index. And if a stock is priced so cheaply, there’s likely a good reason for it. But that doesn’t mean bargains don’t exist. Investigating why a firm has fallen from grace could reveal an overly pessimistic market view that doesn’t consider critical long-term potential.
