Since the start of the year, the FTSE 100 index has only gained around 200 points. After the volatility of 2020, this is a fairly modest performance. One benefit of this is that it’s easier to spot undervalued UK stocks. During periods of high volatility and price swings, it can sometimes be harder to see what’s a fair price. Now that the dust has settled somewhat, I can see more clearly where I’d look to target a £1,000 investment.
Finding undervalued UK stocks
There isn’t one set way of grouping together undervalued UK stocks. I could use the price-to-earnings ratio, which is a relative measure of how overpriced or underpriced a stock is depending on the firm’s most recent earnings.
The problem I have with this is that it’s not easy to compare different stocks, due to different reporting dates. Further, 2020 earnings have been impacted by the pandemic. So the P/E ratios at the moment might actually make it harder to find undervalued shares as the ratios become distorted.
At an absolute level I can simply look at the historical share price movement of a stock. If over the past year the share price has fallen significantly, it’s more likely to be undervalued versus if it was at all-time highs. Again I need to be careful of this as the share price may have fallen for good reasons, reflecting a negative outlook for the future.
The reality of the above is that picking individual UK stocks that could be undervalued is very hard. An easier way for me to allocate my £1,000 is to target an industry instead. If I think an industry is undervalued, then I can invest in a mix of stocks within that industry, reducing my company-specific risk.
An industry I think is undervalued
One industry I’m starting to be drawn to is tourism and hospitality. This has been an area to stay away from during the pandemic as retail spaces have been closed and travel restricted. Share prices of airlines, cinema operators and retailers have fallen. In itself, I don’t think this represents undervaluation. But given recent events, I do think the outlook should boost valuations going forward.
In terms of travel, the UK now has a selection of ‘green light’ countries available to travel to. Thomas Cook reported that bookings have gone through the roof for destinations like Portugal and Cyprus. This will benefit airlines and holiday agents.
Restrictions in the UK have eased again this week, particularly with indoor hospitality. This should mean a key boost for pub operators and the high street in general. So I’d look to allocate funds here and split them between half a dozen companies within this area.
The risk to this industry is simply that consumer demand doesn’t come back as strong as it was pre-Covid. This could be as customers have changed their habits over the past year. Or it could be that variants of the virus mean unrestricted travel isn’t possible for 2021, or that local lockdowns stunt freedom.
Overall, given the difficulty in choosing one undervalued UK stock to invest in, I’d prefer to allocate my cash to a mix of companies within an industry.
