UK value stocks are rising in popularity among British investors following the stock market turmoil in 2022. But what exactly are these types of investments? How can you identify them? And most importantly, how can they be used to grow long-term wealth?
Let’s dive in.
What are value stocks?
Typically shares of a business are classified as either growth or value. The latter category consists of stocks priced below the underlying company’s intrinsic value. A value investor’s goal is to buy shares of a high-quality enterprise for less than what they’re actually worth.
The value investment strategy is almost identical to focusing on buying undervalued stocks. However, there is a slight difference.
A high-growth company whose share price drops can fall into the undervalued territory. But that doesn’t make it a value stock. So, what does?
Characteristics of value stocks
There isn’t a strict definition or standard list of requirements for what constitutes a value stock. However, most share a lot of characteristics, such as:
- Mature business with proven products or services
- Slow but steady growth rates
- Consistent and stable earnings
- Often pay dividends
Value stocks can be considered quite boring. Yet with less interest in this region of the stock market, bargain buying opportunities emerge more frequently than in the growth sector. It also implies that the share price of a value stock is significantly less volatile.
Top value stocks in the UK
The UK is home to a wide collection of mature businesses across a vast number of industries. In terms of identifying which ones are the best value stocks, it’s hard to give a clear answer.
Valuation is quite a subjective progress. That’s why different analysts calculating a firm’s intrinsic value often arrive at vastly different numbers. But there’s no way of finding out which one is correct until after it’s too late.
However, it makes sense to start with a simplified multiples approach using the price-to-earnings (P/E) ratio. It’s also worth adding a few additional selection criteria:
- The business must have a market capitalisation of at least £100m to avoid the risk of stumbling into more speculative territory
- The stock must have an average daily trading volume of 150,000 to ensure ample market liquidity
- Firms must have a minimum average earnings growth rate of 7% to avoid including companies that are shrinking
Based on these requirements, here are the top five potentially undervalued shares in the FTSE 100, as of January 2023:
| Company | Description |
|---|---|
| Segro (LSE:SGRO) | A real estate owner, manager, and developer focused on industrial properties and warehouses. |
| 3i Group (LSE:III) | An investment firm specialising in private equity and infrastructure throughout Europe and North America. |
| Shell (LSE:SHEL) | An international energy and petrochemical business operating across the upstream and downstream supply of energy. |
| Barclays (LSE:BARC) | A UK-based global financial services provider across retail and investment banking, wealth management, and personal finance. |
| Rio Tinto (LSE:RIO) | One of the world’s largest metals and mining businesses, extracting critical materials, including iron ore, aluminium, and copper. |
Segro
Segro is a real estate investment trust that’s been around for over a century. The group focuses on constructing and acquiring big box warehouse facilities in prime locations. However, the portfolio also contains smaller urban logistics centres for customers seeking last-mile delivery solutions.
In total, management now commands 9.6m square metres, rented out to over 1,400 customers across the UK and Europe. Two of its largest clients are IKEA and Deutsche Post.
3i Group
Founded in 1945, 3i Group is a leading international investment organisation specialising in private equity and infrastructure. Today it manages just under £23bn worth of assets across northern Europe and North America.
Using its professional network, private businesses funded or acquired by the group are linked with the right people and facilities to maximise potential. Today there are 45 businesses within its portfolio, including Dutch Barkery, Cirtec Medical, Arrivia, and East Surrey Pipeline.
Shell
Shell started out as a seashell importer back in 1907. Today it’s one of the biggest independent energy companies in the world, operating in more than 70 counties.
Its portfolio primarily consists of oil and gas assets. These are used to fuel global transportation, aircraft freight, and electricity generation. However, as the push for decarbonisation gets stronger, management has begun transitioning its assets into the renewable energy space.
Barclays
Barclays is a commercial bank founded in 1896. It targets both consumers and businesses alike with various financial products. The list includes savings and investing accounts, credit cards, mortgages, corporate financing solutions, and investment banking services.
Despite being based in the UK, the bank operates on an international scale. Most of its income originates from interest charges on issued loans to businesses and consumers. The remainder is derived from fees and commissions for its services with additional contributions from investments and trading activity.
Rio Tinto
Rio Tinto is one of the world’s largest metal and mining businesses, operating in 35 countries. Since its inception in 1873, the group’s portfolio has expanded across numerous raw materials. Today its product portfolio consists of iron ore, aluminium, copper, borates, diamonds, and processed metals like titanium dioxide, which is used in the aerospace industry.
With electric vehicles and renewable energy technology demand on the rise, management has begun investing in lithium projects, due to enter production by 2024.
Investing in international value stocks
Value stocks can be found beyond the shores of the UK. A stock market can be found in almost all developed nations, each with its own collection of value stocks for investors to consider. The most popular is arguably the US.
Being a value investor in the US is a little trickier than here in the UK. This is because it’s home to some of the most exciting growth opportunities that can make value investing seem incredibly dull in comparison. But that doesn’t mean the opportunities aren’t there.
Using the same selection criteria as before, there are the top five value stocks in order of P/E ratio from the S&P 500 index today.
| Company | Description |
|---|---|
| American International Group (NYSE:AIG) | A global insurance firm offering a variety of products, including property and casualty insurance, life insurance, and retirement solutions in over 70 countries worldwide. |
| NRG Energy (NYSE:NRG) | A natural gas and renewable energy producer and services provider operating within the US and Canada. |
| Principal Financial Group (NASDAQ:PFG) | A financial services group offering a variety of solutions to businesses and consumers. |
| Nucor (NYSE:NUE) | A steel products manufacturer producing various materials critical to the construction industry. |
| Pultegroup (NYSE:PHM) | A US-based homebuilder operating under the Centex, Pulte Homes, Del Webb, DiVosta, John Wieland, and Neighborhoods brands. |
How to pick value stocks
At the core of value investing is finding strong businesses trading at a low price point. That’s often easier said than done.
Corporate valuation is an immensely complex topic that even professionals struggle with. The standard approach to estimating intrinsic value requires the construction of discounted cash flow models.
These models aim to predict the present value of a company’s future cash flows based on a series of assumptions. Assuming the analyst is skilled enough to factor in all the potential threats, it’s possible to identify which stocks are trading below their fair value, presenting a buying opportunity.
An alternative and far simpler valuation method is to use price multiples. There are several valuation ratios that can indicate whether a stock is cheap or expensive relative to its peers or industry average.
Some of the most popular ratios used under this technique include:
- P/E Ratio – Arguably one of the most popular valuation metrics, the price-to-earnings ratio is a quick way to compare how much an investor has to pay for each pound of earnings.
- PEG Ratio – The price-to-earnings growth ratio is an extension of the P/E ratio that factors in growth rates to make a more meaningful comparison between two or more companies growing at different rates.
- P/B Ratio – While less popular today, the price-to-book ratio identifies the stocks that are trading below a business’s value if it were to shut down today and pay off all its outstanding financial obligations.
However, relying on these financial ratios alone can be a recipe for disaster. Sometimes a value stock will be trading at a low multiple for a good reason. And any investor buying shares in a seemingly cheap business without knowing why it’s cheap will likely be lured into a value trap.
Should you invest in value stocks?
Focusing solely on investing in UK or international value stocks can be a successful investment strategy. However, that doesn’t make it suitable for everyone.
Growth stocks have the potential to deliver significantly higher returns at the cost of additional risk. This makes investing in growth shares more appropriate for investors seeking to expand their wealth in the long term. Of course, that’s assuming they’re comfortable with the increased risk profile and stock price volatility.
Value stocks do have wealth-building attributes, especially ones that can consistently increase their shareholder dividends each year. However, the pace is much slower, making them more popular with investors seeking to protect the wealth they already have.
Deciding which path to take is a highly personal decision. But nothing prevents someone from investing in growth and value stocks simultaneously to enjoy the benefits of both worlds.