I invest in value stocks to help me outperform the FTSE 100 and FTSE 250. This means I typically invest in companies that look cheap versus their underlying revenue, earnings, and future cash flow forecasts.
It’s a strategy called value investing and it’s one that has consistently outperformed all major indices since the Second World War. In fact, Warren Buffett, one of the most successful investors of the post-war era, is a value investor.
So let’s take a closer look at how it works, and three stocks to help me beat the index.
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Value investing
Value investing essentially requires us to find and invest in meaningfully undervalued stocks. This means companies trading at a discount versus their intrinsic or book value.
Finding these companies requires research. I can start by looking at near-term metrics such as EV-to-EBITDA, or the price-to-earnings ratio. In order for these ratios to be useful, we need to compare stocks in the same sector.
Then there’s the discounted cash flow (DCF) model. This calculation can be more challenging — because making cash flow forecasts isn’t easy — but it also provides us with a better idea of a company’s value.
Value investors tend to hold stocks for a long period. Buffett holds many of his stocks for decades, with some obvious exceptions — he didn’t hold TSMC for long.
Naturally, it can be easier to find these value stocks in bear markets. But I’d also suggest the UK is good place to look for value stocks in general. That’s partially because Britain isn’t overly popular with international investors.
Those three amazing stocks
So I’m looking at three FTSE value stocks to help me beat the index. I’m starting with Barclays. The British banking giant trades with a price-to-earnings ratio of just five, and DCF models suggests it’s undervalued by as much as 70%.
In the short term, I’m concerned about the impact of high interest rates on bad debt. But the medium term picture is much more rosy. I’m buying for a time when interest rates sit between 2% and 3%.
Glencore is another pick. It’s not one I own, but I’ve been watching it closely. A DCF model suggests the miner could be undervalued by 49%. It trades at just 3.9 times earnings. Mining is the second most volatile sector, and this cyclical nature certainly contributes to it’s low valuation. Despite this, I’m still looking at adding this mining stock to my portfolio.
Finally, I like Legal & General. I’ve been topping up recently as the share price pushed lower. It’s a real dividend giant, with an 8.3% yield. It trades at just six times earnings and could be undervalued by as much as 34%.
