FTSE 100: Abandon Ship Or Jump On Board?

Undervalued or overvalued?

The FTSE 100 index is now trading around the highs it recorded at the time of the dot-com bubble. It’s is also hovering around the level it registered in 2008, when the credit crunch brought down some of the largest financial institutions in the world. As such, cherry-picking is the name of the game in town right now.

3 Companies On The Radar 

It’s not easy to invest in the equity markets these days, particularly in the UK, but Associated British Foods (LSE:ABF)Whitbread (LSE:WTB), and Tesco (LSE: TSCO) are three companies whose shares may buck the trend of a declining stock market and may also be favoured by rising valuations. I would hold them as part of a diversified portfolio. 

The FTSE 100 Landscape

It’s a balancing act for the Bank of England. If interest rates don’t rise, the FTSE 100 will likely continue to tread water. And if they rise at a fast pace, the disposable income of the household will be impacted, meaning that accommodative monetary policies will backfire. A strong British pound — which only recently pulled back a bit against the euro and the $ dollar — also complicates things.

According to latest figures from the Office for National Statistics released on Wednesday, “for April to June 2014, pay including bonuses for employees in Great Britain was 0.2% lower than a year earlier, but pay excluding bonuses was 0.6% higher.” This is the first drop in wages, including bonuses, in five years.

This shaky recovery notwithstanding, I’d rule out a market crash — although a correction is well on its way. In this context, Associated British Foods, Whitbread, and Tesco have different risk profiles, but appear attractive compared to more cyclical assets. In fact, I’d avoid miners and banks for some time.

Associated British Foods: An Outstanding Track Record

TABF FINAL LOGOhe Primark owner is a growing business whose shares trade 11.5% below the all-time high they recorded in early July. ABF stock is not the most obvious bet if volatility springs back. In fact, its valuation hasn’t been immune to volatility in recent weeks, but the company’s long-term prospects remain intact, in my view. ABF is expected to grow sales and operating profit at a very fast pace for years to come – just as it has done for a long time now.

ABF’s share price  is up 9% in 2014, and its forward valuation is about 13 times adjusted cash flow, which seems fair. Its debt position is negligible, which means shareholder-friendly activity is a distinct possibility. Margins are thin and the yield isn’t impressive, but ABF has strong track record. Its five-year performance on the stock market reads +243%.

Whitbread: Wake Up And Smell The Coffee 

whitbread2Whitbread is a sound business whose shares trade about 7% below the record high they registered in the first quarter. In tough trading conditions, its valuation could be volatile, but similarly to ABF, its growth prospects are incredibly attractive, and its fundamentals are strong.

It owns Premier Inn and Beefeater Grill as well as Costa Coffee, so the business is a good mix of yield and growth. Its equity valuation is up 12% in 2014 and I believe its shares have more room to run into 2015.

Based on their forward multiples, Whitbread shares trade at a meaningful discount to ABF, in spite of a stronger projected growth profile and higher profitability. Net leverage is manageable and further upside may come from extraordinary corporate activity.

Tesco: Getting Closer To Fair Value

tesco2Tesco is a counterintuitive bet. Its shares are just about to become attractive, in my view. Much of its fortunes depend on how quickly its new chief executive Dave Lewis, who takes the helm of the retailer in October, will deliver a brand new strategy. Investors are worried about the losses in market share, possible dividend cuts and a business model that doesn’t work.

Asset disposals are key to value creation, in my view, and I also believe that Tesco should be attracted to assets outside its traditional core business in the UK. This is the riskiest bet of all, but at 233p a share, Tesco should be on the radar. 

There are alternatives in this market as a few other stocks trade below fair value. Want to know more? 

In this report, our analysts have identified five shares that are currently undervalued and will be defensive if volatility springs back. 

Click here to download this FREE report right now and find out more!

Alessandro Pasetti has no position in any shares mentioned. The Motley Fool owns shares of Tesco. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.