Over recent years, there has been a lot of discussion about the weak performance of the London stock market. UK shares can seem badly undervalued compared to those on markets like New York. FTSE 100 member Flutter listed on the New York exchange (in addition to London) this year and there is City chatter that other firms may do the same.
But what does this mean for me as an investor? I think it could give me a great opportunity to build wealth over the long term. Here is why.
Undervalued or cheap?
When we talk about something being undervalued, that basically means that it sells for less than it seems to be worth.
Given that the FTSE 100 index has been close to its all-time high this year, it might sound a bit odd to talk about it as being potentially undervalued.
But looking at the valuation of many leading UK shares, with price-to-earnings ratios in single digits, things look a bit different.
If those shares are indeed undervalued, it might look like bad news for long-term investors. Over the past five years, for example, blue-chip UK shares like Unilever and Tesco have seen their prices drop (by 12% and 9%, respectively).
But looked at from another angle, such valuations might simply mean I now have a great buying opportunity.
If I can buy into strong companies now while their share prices languish, hopefully over time I could build wealth.
Cheapness versus value
With lots of sophisticated investors poring over the market though, not everything that looks like a bargain may in fact be one.
It could be, for example, that some UK shares are cheap precisely because their long-term prospects seem less attractive now than they did before.
Even if I earn juicy dividends, I could lose money if the value of my portfolio falls.
Buying into Direct Line for its handsome shareholder payout five years ago, for example, I would now be earning no dividends. They have been cancelled. To boot, my shareholding would be worth 43% less than I paid for it.
So when looking for shares to buy, my focus is on finding companies with promising long-term commercial prospects and a share price I think significantly undervalues them.
Hunting for shares to buy
As an example, consider Legal & General (LSE: LGEN).
The 8.2% dividend yield certainly appeals to me. But the FTSE 100 share has lost 13% of its value over the past five years.
I now see it as undervalued.
While post-tax profits fell last year to £443m, for many years they topped £1bn annually. I think they could do so again. Financial services firms’ earnings can be affected by moves in asset values, for example. But looking at cash flows, Legal & General remains a formidable performer in my view.
Its strong brand, large customer base and proven business model have helped generate sizeable cash flows that in turn fund dividends.
Rocky stock markets remain a risk to earnings at the pension provider. But if I had spare cash to invest, I would happily tuck UK shares such as Legal & General into my portfolio now for the long term.
