I think value investors looking for shares to consider buying could do a lot worse than 3i (LSE:III). It’s the top-performing FTSE 100 stock of the last five years, but it doesn’t look hugely expensive.
Despite its stellar performance, the stock trades at a below-average price-to-earnings (P/E) multiple. And while there’s more to it than this, it’s a really interesting business with a lot going for it.
What does 3i do?
3i is a private equity firm. But the thing that sets is it apart from competitors is it focuses on investing its own capital, rather than that of its clients.
This gives it a big advantage. In private equity, clients are typically – and understandably – more enthusiastic about putting their cash to work when they can see things moving in the right direction.
The trouble is, that’s when share prices are high. The best time to be investing is when prices are lower, but there’s usually less enthusiasm for buying stocks when prices seem to be going down day after day.
Investing its own capital gives 3i scope to take advantage of opportunities whenever they appear. And I think this is the key reason the stock has outperformed the FTSE 100 so consistently in the past.
Valuation
The valuation of 3i is a little tricky. A P/E ratio of around eight looks like a relative bargain, but savvy value investors will know there’s a lot more to consider than this.
The company’s earnings can be volatile, which means the P/E multiple can sometimes be misleading. A good example is in 2020, where the Covid-19 pandemic caused profit to drop and the P/E ratio to spike.
3i earnings per share vs. P/E ratio 2014-2024
Created at TradingView
In this situation, considering the price-to-book (P/B) multiple can give a better idea of where the stock is trading. And 3i shares are currently trading towards the higher end of their recent range.
3i P/B ratio 2014-2024
Created at TradingView
This is something investors ought to consider. While the stock looks cheap on a P/E basis, I think there’s a good argument to conclude that it’s actually unusually expensive – and this creates a risk.
Opportunities
When shares trade at unusually high multiples, it’s a sign investors are expecting strong growth. In the case of private equity, this means finding ways to boost its investment returns.
A large part of 3i’s portfolio is taken up with an investment in a European discount retailer called Action. And this has been a source of strong growth in the past.
This can lead to a relatively concentrated portfolio, though, and this is a potential risk. Investors might well think a diversified portfolio could provide more stability over time.
3i, however, has been relatively inactive in terms of new investments for some time. Sooner or later, though, the firm’s continued growth will depend on it finding opportunities to expand its portfolio.
Foolish takeaway
I think there are lots of good reasons to consider buying shares in 3i. The main one is its differentiated business model that lets it take advantage of cyclical opportunities as they present themselves.
Investors, though, shouldn’t be fooled into thinking that a P/E multiple of eight means the stock is cheap – it’s actually unusually expensive. It might still be a good investment, but it needs careful analysis.
The post At a P/E ratio of 8, are shares in this FTSE 100 winner unbelievable value? appeared first on The Motley Fool UK.
But here’s another bargain investment that looks absurdly dirt-cheap:
Like buying £1 for 31p
This seems ridiculous, but we almost never see shares looking this cheap. Yet this Share Advisor pick has a price/book ratio of 0.31. In plain English, this means that investors effectively get in on a business that holds £1 of assets for every 31p they invest!
Of course, this is the stock market where money is always at risk — these valuations can change and there are no guarantees. But some risks are a LOT more interesting than others, and at The Motley Fool we believe this company is amongst them.
What’s more, it currently boasts a stellar dividend yield of around 10%, and right now it’s possible for investors to jump aboard at near-historic lows. Want to get the name for yourself?
See the full investment case
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Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
