UK shares have massively underperformed compared to the S&P 500 over the past decade, but I think 2023 could be a better year for British stocks.
My portfolio is UK-focused. And in recent weeks, that’s been a positive as British stocks have made considerable gains.
But I still believe there are bargains to be found on the FTSE. After all, the majority of British stocks are trading at discounts while the indices have been dragged upwards by surging resource companies.
The thing is, these corrections don’t happen all that often. It might never happen in such a way again. So I’m taking my chance to invest in undervalued UK stocks now, before the market truly recovers.
Market correction
The FTSE 100 is pushing way above 7,500, but the FTSE 250, which is lighter on resource stocks, is down 15% over 12 months. And this is more reflective of the health of most UK stocks.
Certain sectors are suffering more than others. The housebuilding sector has seen some of the biggest losses, with several stocks down more than 50%. That’s huge, but it reflects concerns about the state of the housing market with interest rates at levels not seen in decades.
But other sectors have suffered too, including retail, wealth management and financial services.
The correction is indicative of the downturn in economic conditions. And some stocks are clearly cheap for a reason. But, amid a bear market, I think I have a good chance of finding undervalued stocks.
Given that most UK shares are trading at relatively discounted valuations and that dividend yields have been pushed upwards by falling share prices, I’m constantly on the lookout for cheap stocks with potential upside.
Picking undervalued stocks
There’s no consensus on the best way to value companies. One thing is sure, I need to do my own calculations, looking at metrics and models like discounted cash flow, price-to-earnings, and EV-to-EBITDA.
So I need to calculate what I think a stock is worth, and then see if it’s discounted.
But I’ve also got to be aware of the near-term conditions in which these firms operate. Housebuilders are trading substantially below where they were a year ago. But with rising interest rates, potentially falling house prices, and building cost inflation, it might not be the right time to invest just yet.
Broker AJ Bell says that best-performing UK shares in 2023 will be those in oil & gas, financials, mining, consumer staples and industrials. The former, it anticipates, will see pre-tax profit growth of 24%.
Despite the forecast, I’m staying away from oil & gas. Companies in the sector have been on an 18-month-long bull run, and the situation could change quickly.
Instead, I’m looking at banks such as Lloyds that are continuing to benefit from additional net interest income. With inflation due to start slowing, I’m also looking more closely at firms in retail such as WHSmith and Tesco. Lower inflation should allow for margins to normalise.
I’m hoping that by picking my stocks carefully, I can achieve annualised growth way above my usual 10% target. By focusing on value stocks, I’m hoping to achieve around 15% growth in 2023, including dividends. This really would propel my portfolio forward, and by buying low, I’m also locking in larger dividend yields for the future.
