A strategy of buying cheap UK shares has generally been a successful means of generating superior performance than the FTSE 100 over the long term. After all, an investor who buys a stock at a price that undervalues its future prospects may have greater scope to make capital gains versus paying too much for a company’s shares.
The UK stock market continues to trade below its 2019 level following the market crash. That means a number of buying opportunities appear to be on offer. Over time, stocks currently trading at low prices could deliver high returns that improve an investor’s financial position.
Cheap UK shares within cyclical industries
Many cheap UK shares are priced at low levels because they face challenging operating conditions at the present time. For example, FTSE 100 oil and gas company Shell has delivered disappointing levels of financial performance in recent months owing to falling demand for energy. This situation may persist over the coming months, as the coronavirus pandemic forces lockdowns across the global economy.
However, The company has a solid balance sheet and a strategy that will shift its focus towards cleaner forms of energy. And that could help it deliver an improving financial performance.
With its stock price significantly down on its level from last year, Shell now has a dividend yield of 4% and a forward price-to-earnings (P/E) ratio of 13. Both of these figures suggest it could be cheap relative to other FTSE 100 shares. It may also offer long-term recovery potential as the world economy returns to growth.
Undervalued FTSE 100 shares with solid market positions
BAE could be another worthwhile purchase among cheap UK shares. The defence business currently trades on a P/E ratio of around 10, with investors seemingly cautious regarding its prospects in a challenging global economy.
However, the company’s recent updates have shown it has a resilient financial position, as well as scope to increase its presence in new markets. Furthermore, it’s a long track record of delivering robust financial performance, even during difficult operating conditions for the wider industry.
With a dividend yield of 5%, BAE offers a sound level of passive income that could make up for potential share volatility in the short run. Since defence spending is likely to increase in the coming years, it may prove to be a sound purchase on a long-term basis.
Diversifying among bargain stocks
Of course, Shell and BAE are just two of a number of cheap UK shares that could outperform the FTSE 100 in the next decade. Through owning a diverse range of them within a portfolio, it’s possible for an investor to limit risk and generate high returns. This may lead to an improving financial position as the stock market’s performance strengthens following recent challenges.
Peter Stephens owns shares of BAE Systems and Royal Dutch Shell B. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.