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Here’s Why “Grexit” Doesn’t Matter For The FTSE 100

Fundamentals mean very little in this market and that’s why equity research must reinvent itself into something different these days to be able to monetise its output,” the head of equity research at a bank in the City told me today.

Keep Faith In Fundamentals

Call me insane, but I think that fundamentals mean a lot when it come to identifying value opportunities, whether the market goes up or down. 

There’s been lots of talk about a possible plunge in the FTSE 100 in recent days based on the index’s absolute value (too high) and the default of Greece (very likely) as well as all sort of rumours about other European countries.

I am now worried, although I acknowledge that in order to close the gap with the valuation of many US peers, companies in the UK should be more aggressive in their capital allocation strategies. That said, here’s why you should keep faith in the FTSE 100, which offers plenty of opportunities right now. 

Headline Risk? 

Inflation Rises For First Time Since October” was the headline from Sky News on Tuesday. 

Transport costs helped the UK’s inflation rate turn positive in May after one month of negative inflation,” the BBC noted. 

UK public finances improve more than expected in boost for Osborne,” Reuters also wrote. 

So far so good. 

The UK is not a safe haven perhaps, but its economy looks much stronger than that of most European countries, including France and Italy — all of which spells good news for the main index. 

“Good Volatility”

Greek govt spokesman says government ha submitted proposals,” was the Bloomberg headline I got from a broker a couple of hours ago. 

That alone was enough to determine a meaningful movement in bond prices in Europe’s periphery (down 2%, up 1%, down to 0%…in half a day of trade), which says a lot about the level of “good volatility” that a positive outcome between Greece and its creditors may bring. 

Meanwhile, the FTSE 100 was virtually unchanged.

(Also consider that the index is up 2% this year, while in mid-June 2014 its performance read +0.08% year on year.)

As is always the case in these situations, investors do not feel comfortable holding equity exposure: they fear that panic may spread to other countries whose fiscal deficits are problematic — Italy, Spain, France, to name a few. 

Fundamentals

Value is up for grabs in any market conditions — and I reiterate the view that the FTSE 100 may “de-couple” from other European indexes. 

As my colleague Rupert Hargreaves pointed out at the end of last week, the main index is currently trading broadly in line with its historic average, while other metrics show that it could be undervalued. 

That’s important, but should not determine your investment strategy. 

The first step is to identify companies:

  • whose free cash flow yield is between 3% and 6%;
  • whose earnings per shares not only are rising in the double-digit territory annually, but are properly financed;
  • whose net leverage, as gauged by net debt divided by core adjusted operating cash flow (Ebitda), is between 0.5x and 2.5x;
  • whose dividends are covered by operating cash flows;
  • whose return on equity is in the high 10s/20s, but is not boosted by leverage. 

This is just a necessary starting point before delving into trading multiples and other financial metrics. 

Then, think about sectors that you think may fare well over the next 10 to 20 years, do your research and pay attention to trends and innovation in the technology field -- particularly for companies operating in such countries such as the UK, which continue to offer competitive tax rates and an incentive to launch new businesses. 

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