Buying into FTSE 100 shares means getting a stake in some of the country’s largest businesses.
That might sound as if it would of necessity be a costly undertaking. In fact, some FTSE 100 shares have low prices compared to what I think they are worth. Not only that, but they also offer high dividend yields.
I see quite a few such shares in the current market. Here’s how I go about finding them!
Understanding what value really means
To start with, I look for businesses I like the look of because I reckon they have potential to make strong profits over the long term. If I do not like the look of a business then it may not offer me value even if it has a low share price.
As an example, when Ocado was in the FTSE 100, I reckoned it had still to prove that its business could make money over the long term given its high capital expenditure. I did not invest — and was not alone. The firm has since fallen out of the main index, having fallen 70% in five years.
But even when I do like a company, value means paying less than what I think it is worth.
One approach can be choosing a business with a low price-to-earnings (P/E) ratio. But when doing that I need to watch out for a couple of things.
I look at how sustainable the earnings are. I also consider how much debt (or cash) a company is carrying on its balance sheet. After all, even if a company earns a lot of money, if it needs to use it to pay down debt, those earnings might never trickle down to shareholders.
High yield is not necessarily high risk
So, a share might look like a bargain without actually being one. But some shares, even in the FTSE 100, offer both good value and a high yield without an unusually high-risk profile.
As an example, consider insurer Aviva (LSE: AV).
The financial services powerhouse trades on a P/E ratio of just under 10. I regard that as an attractive valuation for a company that has a large, proven business in a market likely to endure, a sizeable customer base, strong brands, and proven business mode when it comes to generating excess cash.
All businesses carry risks and Aviva is no exception. Indeed, it cut its dividend four years ago. Despite that, the dividend — now growing again — means the insurer’s shares currently yield 7.2%.
For a FTSE 100 firm I find that highly attractive. Indeed, it is around double the average for shares in the blue-chip index.
Aviva strikes me as a share investors should consider buying with an eye to its long-term potential.
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C Ruane 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.
