The FTSE, especially the FTSE 100, is a great place to look for value stocks. Value stocks are those that trade at a discount to their intrinsic, or book, value. And a value investing strategy — one that involves investing predominately in value stocks — has been adopted by some of the most successful investors of all time.
Hunting value on the FTSE
So, why do I think the FTSE is such a great place to look for value stocks?
Well, one reason is that the UK index isn’t broadly popular with the international market. In fact, we can observe that in the lack IPO action seen in recent years. This isn’t going to be the case forever.
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But this lack of love could work to our advantage as UK investors. That’s because as value investors, we want to buy undervalued stocks, and hold them until they’ve reached our valuations.
Moreover, we can observe that the average price-to-earnings (P/E) ratio on the S&P 500 is around 21. By comparison, the FTSE 100 has an average P/E of 13.
The US index isn’t 50% more expensive. We can’t make that comparison — after all, the S&P is filled with ‘expensive’ growth stocks. But broadly, we can observe that sector by sector, UK stocks are cheaper.
So, what are my top value picks? Let’s take a look at three I think investors should buy in May.
Barclays
- Price-to-earnings: 4.98
- Discounted cash flow: undervalued by up to 73%
Barclays has been undervalued for a some time. Discounted cash flow (DCF) analysis suggests a fair value close to 570p. That’s a huge increase from our current position.
I’m a little concerned about the impact of ever-rising interest rates on bad debt. But I think the risks are more than priced in. I’ve been topping up on this stock in recent months, especially after the SVB fiasco sent the share price tanking.
Lloyds
- Price-to-earnings: 6.28
- Discounted cash flow: undervalued by up to 64%
Lloyds is among the most interest rate sensitive banks in the UK. That’s because it doesn’t have an investment arm, and mortgage revenue represents a consider proportion of overall revenue.
So, right now, interest income is soaring. But some analysts are suggesting this is the best it’s going to get for Lloyds because rates will fall from here. I disagree. In fact, I’m investing because interest rates will fall.
In the medium term, interest rates are due to fall to around 2%-3%. And I think this is ideal for banks. When interest rates are lower, impairment charges on bad debt will fall. This represents a much more stable situation than the current high interest environment.
Airtel Africa
- Price-to-earnings 7.8
- Discounted cash flow: undervalued by up to 55%
Airtel Africa is not your average FTSE 100 stock. It’s an Africa-focused telecoms company with considerable growth prospects. But due to several reasons, including the political risk associated with operating in Africa, and perhaps the broader unpopularity of the index, it trades at just 7.8 times earnings.
It’s also worth noting the dividend yield will stand around 4% after a 9% increase in the payout, announced last week. That’s below Barclays and Lloyds, but above the index average. This is one I’m looking to add to my portfolio.
