The FTSE 100 may be trading at all-time highs, but I can still see plenty of cheap shares on the index. And that’s my favourite type.
It’s not (only) because I’m a cheapskate. Buying London Stock Exchange-listed stocks at low valuations eliminates the risk of paying for frothy, overpriced shares, while boosting my chances of bagging a bargain.
Hunting for bargains
I’m likely to get a higher yield when a company’s share price is down rather than up. That’s simple mathematics, given that yields are calculated by dividing the dividend per share by the stock price.
I haven’t invested a penny of this year’s Stocks and Shares ISA limit. That’s something I won’t be able to say for much longer. I’ve recently named my two top ISA targets on these pages.
The first is mining giant Rio Tinto, which currently trades at 9.64 times training earnings and yields 6.16%. The second is Asia-focused bank HSBC Holdings, which yields 6.89% and is valued at just 7.64 times earnings. Both look good value but I accept there are dangers in going cheap too.
The big risk is buying into a value trap, where the share price stagnates until the dividend finally succumbs to reality. I’m looking at you, Vodafone Group.
Turning around a struggling company isn’t easy. Even if the board does get its game on, events beyond its control can wreak havoc. Rio Tinto is helpless in the face of falling commodity prices, for example, while HSBC may end up the jam in a US-China superpower sandwich.
Yet I’ve had plenty of success in buying cheap shares lately. On 30 November, I bought FTSE 250-listed specialist retirement adviser Just Group (LSE: JUST). The business took a beating from 2015’s pension freedom reforms, which liberated pensioners from the obligation to buy an annuity at retirement.
Just was a major annuity provider and sales collapsed overnight. Slowly, it’s been building up its pension savings business, selling equity release lifetime mortgages, and offering bulk annuity deals to businesses.
I love value stocks
The Just Group share price has jumped 25.5% since I bought it and today (15 May) I get my first dividend too. Over one year, it’s up 13.81%.
As the population ages and more people make their own retirement provision, the sales outlook is bright. As ever, there are risks. Annuity sales have rebounded to a 10-year high thanks to rising interest rates, but could slump once rates are cut. Financials have been out of favour for yonks. The yield is relatively low at 2.2%.
However, the group has tangible net assets per share of 224p, more than double today’s share price of 103.8p. As profits surge, I’ve got grounds for optimism.
Even if I only invest £5,000 of my £20,000 ISA limit each year, I reckon I can build a £300,000 portfolio via cheap shares like this.
The long-term average total return on the FTSE 100 is 6.9%. At that rate, my £5k a year would grow to £333,252 after 25 years. If I increased my contribution by 5% a year, I’d get there in 20 years with £325,383.
Investment returns aren’t guaranteed, but that’s a great target. If (and it’s a big if) I can beat the FTSE 100 average return, I’ll end up with even more.
