After a difficult year, UK stocks have fallen out of favour with investors. Paradoxically, this makes me want to buy them.
Many investors, especially those who are just starting out, like to throw money at the best performing shares, in the hope that their good form will continue. I resist this for two reasons.
First, Murphy’s law dictates that I will buy just as the stock runs out of steam. I will overpay and my holding will tumble in value. Second, I prefer to buy cheap stocks that the market has overlooked. This way I get a lower entry point and greater recovery potential.
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I buy what’s unpopular before it recovers
It isn’t a failsafe strategy. That top performer I’ve just shunned may continue to fly, while my cut-price purchase may have been cheap for a very good reason. Yet by and large, I’ve done pretty well out of it.
With £2,000 to invest, I wouldn’t be able to buy all of the stocks I would like. Investing £200 in 10 stocks makes poor business. My online platform charges £6.99 per trade so buying 10 different stocks would cost me almost £70 before I’d begun.
Platforms may be cheaper than they were, but there are other hidden charges. These include stamp duty on share purchases, bid/offer spreads on some stocks, and charges for reinvesting dividends. So I wouldn’t invest less than £500 in any stock, and ideally £1,000.
The ideal portfolio of direct equites should contain at least 15-25 companies. So I’d focus on a couple that I really liked today, and build my position over time.
I’m talking about investing real money here, so I wouldn’t just dive into the first stock that catches my eye. Instead, I would look at the fundamentals of the business.
Is it making a profit? Is that profit rising? Are its margins increasing? How much debt does it have? Does it pay a dividend? Has it consistently increased shareholder payouts over time? Could smaller, nimbler market entrants steal its customers by offering the same service for less?
I like cheap FTSE dividend shares
I would also look at a key figure called the price/earnings ratio, or P/E. This takes a company share price and divides it by annual earnings. A figure of around 15 represents fair value. As a fan of cheap UK shares, I’d look for something much lower than that.
Today, a heap of household FTSE 100 stocks trade at less than seven times earnings, which looks incredibly cheap to me. These include British American Tobacco, Taylor Wimpey, Legal & General Group, Lloyds Banking Group, Barclays, Persimmon and Centrica.
Most of the stocks I’ve listed offer generous yields too. Taylor Wimpey and L&G yield 7.99% and 8.42% respectively.
As with any stock, there are risks. Today’s uncertain mortgage market threatens sales at Taylor Wimpey, while L&G’s fund management arm has struggled amid stock market volatility.
To overcome short-term issues like this, I buy stocks with the aim of holding for at least five or 10 years. That gives them plenty of time to swing back into favour.
By reinvesting my dividends and adding to my portfolio when I have more cash to spare, I’d expect the value of my UK stocks to compound and grow dramatically over time.
