It’s been a very solid start to the year for the FTSE 100, the London Stock Exchange’s benchmark index, which has advanced 3.65% since the beginning of January. 2022 was also a much better year for London’s benchmark index than it was for most major international rivals.
Many leading indices, especially Wall Street’s, saw their worst annual performance since the global financial crisis in 2008 last year as both inflation and interest rates rose to levels not seen for years. Growth companies were worst hit with the tech-heavy Nasdaq down 33% and the broader based S&P 500 losing 19.4%. The pan-European Stoxx 600 index lost almost 13% over the year.
Against that backdrop, the FTSE 100’s near 1% gain for 2022 was a strong performance. It facilitated by the index’s heavy weighting towards energy and commodity stocks, which benefitted from high prices catalysed by the war in Ukraine. For once, the FTSE 100’s historical weakness when it comes to growth stock representation was a boost rather than a drag.
Another factor in favour of the FTSE 100 last year that is still very much worth considering is the fact that it has underperformed for years. First Brexit and then Covid weighed on London-listed stocks. For several years from the run up to the Brexit referendum in 2016 until a (semi) final agreement on the UK’s ongoing relationship with the single market was struck by Boris Johnson in early 2020, international capital shunned the uncertainty.
And just when the final arduously negotiated Brexit agreement provided a level of clarity that international capital started to respond to, the Covid-19 pandemic struck. It didn’t even have the good manners to wait a quarter and London, light on digital economy ‘Covid stocks’, suffered more than most. Less fuel was being used to travel, less energy to heat public spaces like offices and hospitality venues. And less was being built because lockdown restrictions and rules made it a nightmare, weighing on the commodity prices that define the profits of numerous FTSE 100 stocks.
That recent history means that despite the headline figure of a 1% gain for the FTSE 100 in 2022 when rivals were slumping to heavy losses, many of the companies that comprise the index still look much cheaper than comparable stocks listed elsewhere around the world.
2023 gains are again lagging other developed markets, especially Wall Street where the Nasdaq is up over 16%, mainly thanks to a recovery for growth stocks as hopes of a pause or retreat from interest rate rises have taken hold.
London and FTSE 100 stocks still look cheap when compared to peers listed on other exchanges. The UK’s economic prospects still look shaky but Brexit uncertainty is now, to a large extent, a thing of the past. That means that companies whose valuations suffered because they were shunned by international capital could benefit from outsized gains when we return to a bull market, whether that is in 3 months or after 2 years.
And in the meanwhile, the FTSE 100 also still contains energy stocks that look like they will have another strong year on the back of the recent Opec+ announcement that it will reduce oil ouput again.
But there is also danger in a general assumption that all stocks that look cheap at first glance do in fact represent value. As well as opportunities for a bargain there are likely to be plenty of value traps lurking in the FTSE 100 – companies that look cheap on current and historical multiples but have been devalued by the market for good reason – their future prospects are under serious threat.
Against that backdrop, here are 3 FTSE 100 stocks that look like they are cheap today based on current performance and expected future prospects. And 2 that have, for me, the whiff of value traps.
3 FTSE 100 stocks for the long haul
The three FTSE 100 stocks I think currently look like they could (there are no guarantees) represent a buying opportunity are:
- National Grid
- Scottish Mortgage Investment Trust
- Taylor Wimpey
National Grid – a solid income stock that looks safe if not spectacular
The privatised infrastructure company behind the UK’s electricity grid and gas infrastructure, National Grid’s value has gained almost 12% this year but is still down over 4% for the past 12 months. A utility infrastructure stock like National Grid is never likely to deliver spectacular gains but at a backwards-looking p/e ratio of just 13 and forward looking 15 this looks an attractive portfolio foundation choice at a fair value.
One of the biggest strengths of National Grid, especially in the current uncertain economic environment, is its defensive qualities. The company has a natural and protected monopoly position in most of its markets and we’re never going to stop needing electricity and gas. Regardless of the economic environment, revenue is never going to slump and the company is targeting an encouraging 6% to 8% annual revenue growth over the next few years.
National grid is also a solid income stock offering a 4.8% dividend yield at the current valuation. The company also has a consistent track record of raising its dividend, which has reached 55.2p-a-share from 45.7p in 2019.
The one downside is the company’s £46.5 billion of net debt, which could weigh on profits and dividends if servicing costs increase with further interest rate rises. However, it’s not unusual for an infrastructure company like National Grid to have relatively high debt and the company plans to pay it down over coming years.
Scottish Mortgage Investment Trust – approaching an inflection point?
One of the FTSE 100’s best performers during the stock market boom that preceded 2022’s downturn, the Scottish Mortgage Investment Trust invests in mainly tech growth stocks. That sector’s huge success during the long bull market translated into impressive returns for investors in the trust. But also means it was hit hard by the tech sector correction in place since late 2021.
Shares in the trust are currently at their lowest valuation since the first half of 2020 and analysts are starting to speculate if now is a good time for investors to return to it. A Financial Times report in late March highlighted a marked drop in the number of hedge funds shorting the stock, indicating they too believe it could now be approaching a turning point.
The biggest risk at present is that the trust is almost at the 30% limit of assets that can be invested in non-listed private companies. That means it has very little flexibility to make new investments in non-listed companies which could see it miss out on opportunities, especially the ability to participate in new funding rounds of companies it already holds stakes in.
Investors should approach any investment in Scottish Mortgage with a degree of caution as the environment for growth stocks and non-listed tech and biotech startups is still shaky and it’s difficult to predict when the bottom will be reached. There could still be further losses for the stock before a return to health so a drip-feed approach would be advisable.
Taylor Wimpey – safe as houses?
Housebuilder Taylor Wimpey’s valuation has dropped by over 37% in the past five years and 8% over the last 12 months. Despite an impressive year-to-date gain of 16% in 2023, the company’s longer term decline in value means it still looks attractively priced.
Taylor Wimpey’s p/e ratio currently stands at just 6.75% and it offers a dividend yield of almost 8%. The company’s valuation jumped by almost 7% last week after the Thursday release of a report by the Royal Institution of Chartered Surveyors projected growing property sales in the latter months of 2023.
Back in January, analysts at Liberum Capital said they expected average upside of 28% for UK housebuilders this year if property prices decline by around 5% in 2023. The outlook for the housing market will move with interest rate movements and the wider economy this year but unless things take a significant turn for the worse, Taylor Wimpey looks good value.
Even if the economic headwinds prove stronger than expected this year, the longer term prospects for this stock look attractive.
2 FTSE 100 stocks that look like potential value traps
The two FTSE 100 representatives that look cheap at first glance but I would be very wary of are:
- Tesco
- Lloyds Banking Group
Tesco – some positives but a tough market environment raises doubts
Tesco, the UK’s largest supermarket by market share has had a volatile past few years, down 11.5% over the last five, but a good 2023 so far, up 17.7%. Historically, supermarkets are a good defensive stock during economic downturns as people don’t stop grocery shopping. For the same reason, supermarkets have reasonable pricing power and can pass inflation on to shoppers, protecting margins.
However, the supermarket sector in the UK has been incredibly competitive for years, squeezing margins. And if anything, as new rivals including the mighty Amazon eye the UK groceries market, Tesco’s competitive environment will only become more cut throat over the next several years.
Inflationary pressures are also proving a drag with competition meaning they can’t be fully passed on to customers. Rising costs saw full-year pre-tax profits fall by 50.8% to £1 billion (from £2 billion the previous year) in the last financial year despite a 7.2% rise in revenues.
A recent flat forecast by Tesco warned investors of a continuingly difficult environment and the company expects adjusted operating profits from its retail business, which makes up the bulk or revenues and profits, to remain flat in 2023/24.
In Tesco’s favour are the announced £750 million addition to its share buyback plans, demonstrating confidence, and £550 million in cost savings that keep it on track for the £1 billion target it has set itself to achieve by February 2024.
Investors who own Tesco shares may well see strong enough arguments to hold onto them but for new investors, 2023 may not be the right moment to take exposure to the company.
Lloyds Banking Group –
The share price of Lloyds, the UK’s biggest mortgage lender, has decline by a quarter in the past five years. With interest rates higher than they have been for years and potentially rising further if inflation doesn’t show definitive signs of imminently falling significantly, Lloyds’s could be expected to see an upturn in fortunes as loans rise in profitability.
Despite that, the market has remained very lukewarm on Lloyds, which trades at a p/e multiple of under 7. At first glance that looks cheap when compared to other London-listed banking stocks like HSBC and Standard Chartered. Both trade at a p/e of close to 10.
However, a closer look at FTSE 100 banking peers Barclays and NatWest show more comparable multiples, with the former a much cheaper looking p/e of just 5.1 and latter 7.6.
What all three have in common is that they are UK-facing and their fortunes rely on the domestic market, and economy. HSBC and Standard Chartered, meanwhile, generate the majority of their revenues in quickly growing international markets across Africa, Asia and the Middle East.
With the UK economy quite possibly entering recession, the mid to longer term growth outlook relatively uncertain at best and many analysts expecting interest rates to relatively quickly come back down to much lower levels again, Lloyds may not be so cheap after all. Despite its valuation sitting a long way off its most recent highs – themselves a fraction of the bank’s pre-financial crisis levels.
But I think the market’s caution on Lloyds is well founded and wouldn’t be enticed by the 25% its value has dropped in the last half decade. It could be facing another tough patch to navigate.
