I like a bargain – who doesn’t? – and that’s why I’m keen to buy dirt-cheap shares for this year’s Stocks and Shares ISA allowance. Buying top UK companies when their shares are relatively depressed can be a winning strategy, provided I’m patient. By investing during the lows of the market cycle, I hope to benefit from the upswing when it comes.
Of course, there’s no guarantee that will happen. Some shares are dirt-cheap for a reason. A company could be in trouble, and get even cheaper still. Nobody gets it right every time.
I still think now is a good time to hit the sales. Despite last year’s recovery, the FTSE 100 has idled for a while. US tech stocks have been selling off. Investors got carried away with last year’s vaccine breakthroughs, but now have two worries.
I’m looking for dirt-cheap shares
The first concern is that the pandemic could drag on as many vaccination programmes prove sluggish. The second is that when people are set free they will go an an almighty splurge and the global economy will overheat.
President Joe Biden’s stimulus plan has worsened inflation fears, as it will pump another $1.9trn into the US economy. Last year’s fiscal and monetary stimulus is already being followed by weird bubbles, such as the Reddit GameStop frenzy, and Bitcoin.
Investors seem to be worrying about a recessionary slump and inflationary boom, at the same time. But I think second-guessing markets in this way is a fool’s game either way. I listen to ace investor Warren Buffett on that subject, who said: “I never have an opinion about the market because it wouldn’t be any good and it might interfere with the opinions we have that are good.”
With that in mind, all I can do is search the market for shares I think are dirt-cheap today, and then hold them until the market (hopefully) comes round to my way of thinking.
I might use the P/E ratio to identify potential dirt-cheap stocks. The FTSE 100 is full of good companies trading at less than 10 times earnings right now. That would only be a starting point, though. I would then look at earning patterns both before and during the pandemic, and analyst projections for the future.
The ISA season is here
I would work through recent company results and reports, to see where management thinks opportunities lie, and whether I agree with them. I would look at how much cash companies generate, and how much debt they carry. My aim is to work out whether a particular dirt-cheap share is a bargain or value trap.
I would favour companies with a strong competitive ‘moat’ that deters competitors. Then I would listen to Warren Buffett again. He said: “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”
That’s my minimum time scale and should give my dirt-cheap shares plenty of time to swing back into form.