If you can find the best shares to buy now, holding undervalued companies could make you a fortune. Some of the world’s richest and best known investors rely on it.
Warren Buffett, Peter Lynch and Jim Slater. What do they have in common? Each made their fortune by picking cheap shares relative to their intrinsic value or their rate of growth.
Happily we don’t need to develop our own super-complex systems to find the best shares to buy now to make a million pounds.
Passive income stocks: our picks
Do you like the idea of dividend income?
The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?
If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…
Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.
What’s more, today we’re giving away one of these stock picks, absolutely free!
Figuring out
I’m using simple value investing principles and calculations to help me make seven figures in my Stocks and Shares ISA.
Remember, all we need is a return of 7% a year. From a standing start, £750 a month in an ISA with dividends reinvested will produce a million pounds over 32 years.
To find which are the best shares to buy now, there are a couple of super-useful value investing tools that you need to know. In this article I’ll outline each one in turn, along with a suggested share.
Price-to-earnings ratio
First we need to consider the price-to-earnings ratio, often written as the P/E ratio.
This is a measure of a company’s share price relative to its earnings. It’s an easy way of comparing businesses in wildly different industries and at different growth stages. That’s why it’s a useful tool to create a shortlist of the best shares to buy now.
The average P/E ratio of the FTSE 100 in August 2020 is 13.4. So anything below that number we can reasonably call cheap. But this figures is never set in stone. If share prices fall, the P/E ratio drops too.
For example, I bought Aviva at a P/E ratio of just 4.4 after the stock market crash in March. Why? Because I thought the company was solid and would recover. And I’ve gained 22% on my investment in the last couple of months. Four years ago, the Aviva P/E ratio was at 31.
So which do I think are the best shares to buy in the FTSE 100 now? I’d pick British American Tobacco (P/E of 9.4). It pay a whopping 8% dividend with decent cover of 1.3 times earnings, making it a super share for me.
Best shares to buy now
Another helpful metric we can use to determine undervalued companies and find the best shares to buy now is by looking at the PEG ratio, or price-to-earnings-growth ratio. Just divide the P/E ratio by a share’s expected percentage growth rate.
Jim Slater popularised the method in 1992’s The Zulu Principle. That was the first serious book I read about choosing undervalued shares and comes strongly recommended.
Slater writes that the point of buying shares with low PEGs is that “they provide the element of safety normally association with low-risk investments without sacrificing the upside potential of growth stocks.”
The best shares to buy now have a PEG ratio between 0 and 1. Not too fast, and not too slow. Just right.
My recommendation? I like the £7.5bn long-term capex commitment at SSE. It’s trading at a PEG ratio of 0.4.
The FTSE 100 renewable energy company recently agreed to reinstate its 6%-yielding dividend. And even better, the company has recommitted to its five-year plan to keep dividend growth improving faster than inflation.
