Billionaire investor Warren Buffett is renowned for buying undervalued shares when stock markets are on the back foot. He makes no secret of it. 

“The best chance to deploy capital is when things are going down,” Buffett said, so there should be plenty of opportunities amid the current uncertainty. Despite rallying in recent days, the FTSE 100 is down 4.32% year to date.

Some of my favourite shares have fallen by a lot more than that. I would like to buy one or two of them in November. But which?

I’m listening to Buffet

Buying undervalued shares works because stock markets are broadly cyclical, as are individual sectors and stocks. If I buy a stock after it has enjoyed a blistering run and investors are falling over each other to snap it up, there is a danger I will end up overpaying. This may leave me exposed when the wheel of fortune turns.

If I buy a stock when it looks down and out, I will secure a cheaper entry price, and reap the rewards if it recovers. That’s a big if though.

My aim isn’t to buy cheap shares. That’s the easiest thing in the world. It is also a good way of building a portfolio of bombed-out growth stocks and eternal value traps. Buffett preaches the importance of buying stocks that are good value instead. 

Values stocks have been deeply discounted by the stock market, while the underlying business model remains strong. Again, this doesn’t mean simply buying the cheapest in the sector. I’m willing to pay relatively more for a company if its prospects are brighter.

This means buying a stock that is valued at below its underlying worth. As Buffett said: “Price is what you pay, value is what you get.”

He also likes to buy companies with wide economic moats, as that helps to protect them against competitors and new entrants. This strategy has made Buffett supremely rich, but then he’s an investment genius and I’m not.

FTSE 100 is full of undervalued shares

I’m just a private investor trying to pick up a bit of knowledge. Buffett famously said: “Never invest in a business you cannot understand.” I would modify this, and say never follow an investment strategy you do not understand.

The strategy of buying undervalued shares and waiting patiently for them to recover is so simple even I understand it. It’s the old ‘buy low, sell high’ mantra.

There are plenty of opportunities to buy low over the months ahead, as central bankers tip the world into recession to kill inflation. Buying undervalued shares should give me downside protection if markets head south, and turbo-charged recovery when they rise. That’s the theory, anyway.

It means I can buy FTSE 100 stocks today and don’t have to worry too much if share prices fall again tomorrow. It’s going to be a volatile winter, but when markets fall, I will take my chance and buy some more undervalued shares.

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I remember when Unilever (LSE: ULVR) was arguably the most popular and admired FTSE 100 stock on the index. It wasn’t that long ago, either.

The packaged food and consumer goods giant was seen as a stock for all seasons. As a purveyor of soap, shampoo, bleach, sprays, and ice cream, sales rose when consumers were feeling flush. Yet revenues held up in the bad times, too, as people cut back on luxuries rather than Unilever’s low-cost everyday essentials.

I’m hunting for FTSE 100 stocks

Fundamentally, Unilever hasn’t changed. It still boasts a raft of huge global brands including Axe, Ben & Jerry’s, Dove, Lifebuoy, Hellmann’s, Magnum, Persil, Sunsilk, Vaseline and Wall’s. Customer numbers are soaring as emerging markets play catch up with the West.

What has changed is that management has lost its way. Critics have accused the board of pursuing a ‘woke’ agenda while failing to pay attention to the bottom line. Unilever also missed an open goal in the pandemic, by failing to boost hygiene and packaged food sales.

Its big shareholders are unhappy. Activist hedge fund investor Nelson Peltz acquired a stake in the wake of Unilever’s failed £50bn bid for GlaxoSmithKline’s consumer-health business, hoping to force change. He’s now on the board.

Peltz isn’t the only investor who thinks the business is in need of a shake-up. The Unilever share price certainly needs a fresh injection of life. It’s up just 1.6% in the past 12 months, and down 14% over three years.

It is struggling to make headway despite reporting an 8.1% increase in first-half underlying sales in July, as strong pricing offset input cost inflation. All four divisions delivered, and management expects underlying sales growth for 2022 to beat previous guidance of 4.5% to 6.5%.

Unilever appears to have pricing power, which has enabled it to hold full-year underlying operating margins within its guided range of 16% to 17%.

I’m a private investor, not an activist investor. I accept that Unilever needs an overhaul, but I still think the underlying business is strong. Personally, I would rather buy before it is on the mend, to take advantage of today’s highly tempting entry point.

I’ll buy Unilever this month

For years, Unilever has been trading at around 24 times earnings and yielding around 2.5%. Today, its valuation has dropped to 17.6 times earnings while its dividend yield is a halfway handy 4.4%, covered 1.5 times by earning.

Yes, the “medium-term macroeconomic and cost inflation outlooks are uncertain and volatile”, to quote Unilever itself, but that is partly reflected in today’s price.

I am currently hunting for FTSE 100 stocks at bargain prices, with the aim of holding them for at least 10 to 15 years. Having such a long perspective means I don’t have to worry about a company’s short-term problems.

So far I’ve bought FTSE 100 stocks Persimmon and I’m gearing up to buy Rolls-Royce. Once I get the cash, I’ll buy Unilever, too. Certainly before the month is out.

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Harvey Jones holds shares in Persimmon. The Motley Fool UK has recommended Unilever. 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.

A year ago, I was seriously considering buying Tesco (LSE: TSCO) shares. This was before the Ukraine war, the energy price shock, and the cost-of-living crisis.

My biggest worry at the time was whether the economy was bouncing back fast enough from Covid lockdowns, amid ongoing supply shortages. Boris Johnson was Prime Minister, and Rishi Sunak Chancellor. It was a different world.

An awful lot has happened since then, and it has hit Tesco shares hard. They have fallen 21.11% in the last 12 months. By contrast, the FTSE 100 is down just 3.08% over the same period.

Lucky I didn’t buy Tesco shares

I’m glad I didn’t buy Tesco shares back then. The stock currently yields 5.04%. So even after reinvesting my dividend payout, I would still be sitting on a 16.07% loss.

If I had invested £1,000 a year ago, I would have £839.30 today. That’s not a disaster, but it’s not great either.

Naturally, Tesco has been hit hard by the cost-of-living crisis. While the group’s costs have increased, shoppers have less money. The £16bn FTSE 100 company may be the UK’s biggest grocer, with a 27% market share, but it lacks pricing power in a competitive market, with Aldi and Lidl sniffing.

Tesco’s profit margins have always been tight, and currently stand at just 4.2%. That is now forecast to shrink to a wafer-thin 2.9%. Tough times indeed.

What’s past is past. I dodged a bullet in 2021, the big question now is this. Should I buy Tesco shares today?

Food may be a consumer staple, which should theoretically underpin sales in hard times, but UK food retail is not a happy place right now. Credit Suisse has trimmed its target price for Tesco, from 292p to 238p. Today, the stock trades at 216p, which doesn’t leave much of an uplift.

Tesco has also been hit by the weak pound, which has driven up import costs. Sterling may strengthen with Rishi Sunak as PM, but there is still a long way to go.

Companies that operate in a competitive market cannot afford to stand still. Tesco needs to invest in its online operations, boost automation, and minimise delivery disruption. All this costs money, and will squeeze margins further.

It’s on my Christmas wish list

The peak Christmas period is coming, but so are peak electricity bills, and shoppers won’t feel any richer come the festive period. Tesco sees full-year profits “at the lower end of guidance”, with retail adjusted operating profit falling from last year’s £2.65bn to between £2.4bn and £2.5bn.

The result is that Tesco shares trade at 9.7 times earnings. So the entry valuation looks attractive, offsetting many of the risks. Its current yield is also covered twice, which gives me confidence that the dividend will be maintained, and increased, too.

That dividend should tide me over until the shares recover. I recently bought Persimmon and I’m lining up Rolls-Royce as my next buy, when I have the money. I’m now adding Tesco to my watchlist, and hope to buy it before Christmas.

Tesco shares may take some years to recover, but I will reinvest my dividends to pick up more stock while I wait.

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Harvey Jones holds shares in Persimmon. The Motley Fool UK has recommended Tesco. 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.

Finding FTSE 100 stocks to buy in November seems relatively easy to me. After this year’s stock market dip, the index is packed with dirt-cheap bargain stocks. Many are available at such low valuations and pay such high dividends, it almost makes me suspicious.

Some of these FTSE 100 stock opportunities are clearly too good to be true, but others aren’t. The big question I face is, which ones are true bargains and which are hidden value traps?

Here’s how I’d buy FTSE 100 stocks

The FTSE 100 no doubt has plenty of both. I would start by looking at company fundamentals, such as whether it has a strong balance sheet, popular brand, unique product or loyal customer base.

Companies in this position should offer me superior long-term growth opportunities, whatever the economic weather.

I would also look at how each sector has performed. For example, energy stocks have done brilliantly this year, as prices rocket due to the war in Ukraine.

But what threats does they face now? A slowing global economy could squeeze the oil price as demand falls. 

Expectations of winter energy shortages may prove alarmist, as European countries have embarked on a largely successful scramble to fill storage facilities. Energy prices may relent.

I would apply the same thinking to, say, the banking sector. Banks are likely to benefit from rising interest rates, as it allows them to widen their net interest margins, the difference between what they pay savers and charge borrowers.

Yet rising interest charges will also increase loan impairments, as business and personal customers struggle to service their debts.

I also have to decide whether to go shopping for shares in beaten-down sectors, in the hope they will recover, or target high-flying sectors that may have even further to climb.

After finding a tempting sector, the next decision is which stock to buy. I always start by examining basic numbers such as valuations and yields. How do they compare to rivals on metrics such as revenues and customer bases?

Then I might look at their profit trajectory over the past five years, and glance at their forecasts too.

I will check out recent reports and trading statements, to see where the opportunities and threats lie. While I’m at it, I would check their net debt and cash flow figures.

I’m investing

Finally, I would look at my own financial and emotional position. Can I afford to take a big risk right now? Am I investing for income and growth? What is my timescale for holding the stock? Will it balance my existing holdings?

Only once I have addressed all of his questions will I click the ‘buy’ button and add another stock to my portfolio, or top up an existing one.

That’s a lot of questions to address, but the nights are drawing in and building a portfolio of shares will prove more rewarding in the longer run than gawping at the telly.

November is almost upon us. It’s time for me to buy more FTSE 100 stocks.

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Harvey Jones doesn’t hold any of the shares mentioned in this article. 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.

Anybody who loves top dividend stocks will struggle to resist going on a buying spree at the moment. The FTSE 100 is packed full of them.

Some of the yields on offer are astonishing. Housebuilder Persimmon currently yields 17.9%. That’s the best on the FTSE 100 but mining giant Rio Tinto isn’t that far behind, with a yield of 12.87%.

Fund manager Abrdn yields 9.37%, insurer Phoenix Group Holdings yields 9.07%, and builder Taylor Wimpey yields 9.05%. Wow.

I’m buying dividend stocks today

There are plenty more where those came from. In fact, I can hardly remember a time when yields were so high. But can I trust them?

A yield is calculated by dividing a company’s dividend by its share price. So if the dividend is 5p and the share trades at £1, the yield is 5%. This means that if the share price halves, say, to 50p, the yield doubles to 10%. 

As this basic example shows, a high yield is often the sign of a company in trouble. It signals both an opportunity, and a threat.

If stock markets are down generally and my chosen dividend stock has got caught up in the wider malaise, then I’ll see that as an opportunity. Loads of stocks fits the bill right now, thanks to this year’s global political and economic turmoil. 

But I would also work through its reports, statements, and updates, to see whether there are problems specific to that company. In particular, I would look to see whether management can afford to continue paying its dividend. The easiest way of doing this is to check dividend cover. This is calculated by dividing shareholder payouts by company earnings, but it can also be found easily online. 

Ideally, it will be covered twice or more. This figure is often lower with utilities, where earnings are typically more reliable, allowing companies to hand more of them to shareholders. A healthy level of cover is no guarantee, but it’s a promising sign that the company will be able to continue paying me passive income in future.

I would also look at other company numbers, such as the size of its net debt and of course the reliability of its free cash flows, which fund shareholder payouts. Similarly, I would prioritise firms with a lengthy track record of making dividend payments. Especially those who maintained them through thick and thin (and the pandemic, too). 

FTSE 100 offers amazing yields

Any company that increases its dividends year after year would be high on my list, as this gives me a rising passive income. While past performance is no guide to the future, it does offer reassurance.

As a general rule, I would prefer a company with a lower dividend that looks more reliable, than a higher dividend that is likely to be cut. When a dividend is cut for being unaffordable, the company’s share price tends to bleed, too.

Naturally, a host of other factors will determine whether the dividend is sustainable. A strong balance sheet, loyal customer base, unique brand, or popular products can all help secure those all-important cash flows. 

While I’m thrilled by all the top FTSE 100 dividend stocks out there right now, I’m doing some careful sums before buying them.

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Harvey Jones holds shares in Persimmon. 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.

Buying FTSE 100 shares is always a bit scary but particularly in turbulent times like these. Nobody wants to buy a company only to see its value plunge the next day in a stock market crash.

This year has been particularly volatile, due to war in Ukraine, post-pandemic supply shortages, ongoing Covid lockdowns in China, the energy shock, and widespread political turmoil. Investors have to be brave to exchange their cash for FTSE 100 shares.

Although maybe not that brave. The FTSE 100 has performed relatively well this year. It is down just 6.19% year-to-date while the US S&P 500 has fallen 19.54%.

Second-guessing the FTSE 100

London’s blue-chip index has held up relatively well because it is packed full of solid, undervalued dividend stocks. Investors are wary of buying overvalued stocks as sentiment turns negative, as they are more vulnerable in a crash. They also value dividends more than they did, as a regular stream of shareholder payouts can help offset some of the damage inflation is doing to their wealth.

Just because stock markets have crashed does not mean they can’t fall even further. So what do I think will happen next?

The honest, boring, and disappointing answer is that I have absolutely no idea. If I pretended otherwise, it will be a liar or a fraud. Or both.

There are simply too many variables for anyone to second-guess market movements with consistent accuracy (and no supercomputer will ever do it, either). Of course, everyone is entitled to their opinion, but that’s all it is. An opinion. It means nothing.

In case you feel let down, I’ll tell you what I do know. The FTSE 100 has fallen this year. Therefore stocks listed on the index are cheaper than they were. This presents me with a buying opportunity, but also poses a threat.

Before buying a bargain stock, I would like to know why its share price has gone south. Sometimes the reason will be beyond its control. For example, a housebuilder is likely to have fallen sharply this year, as investors assume rising mortgage rates and input costs will hit demand.

I’m not even thinking about a stock market crash

Yet every stock in the housebuilding sector will not have fallen at exactly the same speed. A company with a worryingly high level net debt is likely to have fallen faster than a rival with a tiptop balance sheet. Similarly, one with a strong order book or well-covered dividend will perform better than one without these things.

Those operating in areas of the country where demand is likely to remain relatively solid are also likely to have an edge. I will take factors like these into consideration when buying any stock. They can help me separate the wheat from the chaff.

I’m not going to spend time working out where the market is likely to rise or fall. Instead, I will devote my energies to looking at individual stocks, and seeing whether their numbers add up. There’s still an element of speculation involved and they could fall next day if stock markets do crash, but I reckon this lifts the odds in my favour.

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Harvey Jones doesn’t hold any of the shares mentioned in this article. 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.

I don’t want to rely solely on the State Pension in retirement, so I’m keen to generate a passive income of my own. One way I do this is by investing in FTSE 100 shares, which offer some of the most generous dividends in the world.

At time of writing, the average yield across the FTSE 100 is 4.1%, which looks good to me. Especially since any share price growth when markets rise will be on top of that.

I’m investing for passive income

I will put my dividends to work in two ways. Initially, I will reinvest them back into my portfolio so that they compound and grow over time. Later, I will draw those dividends as income when I retire. By investing inside my annual Stocks and Shares ISA allowance, I can take that income tax free.

How much passive income I could generate will depend on factors such as how long I invest for, how much I pay in, and how well my shares perform. Let’s say I invest £3 a day. That’s around £90 a month, or £1,095 a year.

Let’s also say I was starting from scratch aged 25, increased my contribution by 3% a year, and generated a total average return of 7% a year. By 67, I would have a portfolio worth £400,809.

That’s not a bad return from investing £3 a day (and rising). If my portfolio of FTSE 100 shares was yielding 4.1% at that point, it would give me income of £16,433 a year. That’s way above my £5,000 target, which would be brilliant. Apart from one thing. I’m not 25.

If I started at 35 applying the same assumptions as above, I would have £179,854 by 67. That’s a much lower figure and underlines the importance of investing as early as possible. On the plus side, it would still generate income of £7,374 a year.

So if I waited until 45 instead, I would fall short of my target. With just 22 years to retirement, I would generate just £73,647 by the time my 67th birthday comes around. My income stream would fall to just £3,020 a year, assuming the same 4.1% yield.

Sooner I start buying shares, the better

I am actually 15 years from my anticipated retirement date. Luckily, I’m not starting from scratch, but if I was, I would need to invest £10.50 a day (£3,833 a year) to achieve my original passive income target of £5,000 in retirement.

Investing that much would give me a pot of £122,731 and income of around £5,032 a year, using all the same assumptions.

As these figures show, there is no time to lose in the battle to gain sufficient passive income for retirement. Now looks like a particularly good time to get stuck in, as there are loads of FTSE 100 dividend stocks available at dirt-cheap valuations in the current turmoil.

Plenty of them yield 6%, 7%, or 8% a year, or more. That’s a lot more than 4.1%. If I targeted higher-yielding stocks, I could potentially generate much more than £5,000 a year, but with a bit more risk.

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Harvey Jones doesn’t hold any of the shares mentioned in this article. 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.

I’m no longer 40 years old but if I was and had no retirement savings, I’d follow the same strategy as I do in my 50s, and invest in FTSE 100 stocks.

Although the first thing I would do is kick myself, for leaving it so long to take investing seriously. That’s because I have learned that the longer my money sits in the market, the more time it has to compound in value. That is particularly important when investing in the FTSE 100, as it is packed full of top dividend stocks paying mighty yields.

I’d pile into FTSE 100 stocks

Some of my favourite companies on the index haven’t delivered much share price growth over the last five years or so. Many have fallen sharply over the last 12 months. That doesn’t put me off, because they now look dirt cheap and their yields are huge. Many of my favourite FTSE 100 stocks yield between 5% and 8%. Some pay even more than that.

If I was 40, I would reinvest all my dividends straight back into my portfolio, again, exactly as I do today. My reinvested dividends would pick up more stock, which would pay more dividends, which I would reinvest to buy yet more stock.

This is a virtuous circle and even I started from scratch at 40, I would still expect to build a decent pot of money by the time I reached state pension age.

Let’s say my FTSE 100 shares delivered a total return of 7% a year, which is roughly the long-term average across the index. If I invested a lump sum of £10,000, that would grow to £62,139 by age 67 years. That’s a pretty decent return.

If I followed that up by investing £300 a month, which is £3,600 a year, I would end up with a thumping £349,050. Again, this assumes 7% a year growth.

I’d buy cheap value stocks

Here’s another thing I would do. I would increase the amount I invested each year, to keep up with inflation. Let’s say I increased that £300 monthly contribution by 3% a year. By the time I hit 67, I would have £446,624 in total. 

Of this, £290,069 would have been pure profit from compound growth. That’s an impressive two-thirds of my total portfolio.

I think now is a tempting time to start buying FTSE 100 stocks because the index is packed full of bargains. I can scarcely believe my eyes when I see dividend aristocrat Legal & General Group trading at 6.87 times earnings and yielding 7.94%. Or housebuilder Taylor Wimpey, whose valuation has tumbled to just 5.28 times earnings, while it yields 8.91% a year.

Mining giant Rio Tinto is currently valued at just 4.09 times earnings and yields a staggering 12.09%.

Of course, dividends are not guaranteed, and share prices can always fall. No stock is ever totally safe. That’s why I would invest in a balanced spread of FTSE 100 stocks, to spread my risk. I would also pay in as much as I could afford today, to ensure a comfortable retirement tomorrow. That would apply whether I was 30, 40, 50, or older.

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Harvey Jones doesn’t hold any of the shares mentioned in this article. 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.

Scottish Mortgage Investment Trust (LSE: SMT) shares have had a rough ride, falling 47.4% in the last year. That is quite a fall from grace, for what was until recently a FTSE 100 stock market darling.

At its peak, it had delivered a staggering 500% return over five years. It did this primarily by piggy-backing on the boom in US technology stocks, with electric car maker Tesla its biggest holding.

Scottish Mortgage shares are struggling

Clearly, Scottish Mortgage didn’t mind taking a few risks, although I wonder whether lead manager James Anderson saw the writing on the wall. He stepped down in April, after 22 years at the helm. At its peak, his trust was worth £18.5bn. Today its market value is £10.9bn. 

If Anderson had retired one year earlier he might have escaped any blame for his share in the Scottish Mortgage carnage. I had become increasingly uneasy in recent years, as it looked like Anderson was taking too big a gamble on the frothy US market. That is the main reason why I resisted buying it.

Let’s say I had bought it exactly 10 years ago today. What would I have now? A decade ago, Scottish Mortgage shares traded at around 142p. At time of writing they stand at 742p, despite the stock meltdown.

If I had invested £1,000 on 26 October 2012, I would have bought 704 shares. Today those shares will be worth £5,223. That’s an increase of 422%. Not bad, although roughly a year ago, I would have been sitting on a much bigger gain.

Scottish Mortgage shares peaked at 1,528p recently as 5 November last year. At that point, my 704 shares would have been worth £10,757.

In practice, they’d have been worth even more, assuming I reinvested my dividends to buy more stock. With an annual yield of just 0.47% Scottish Mortgage isn’t exactly a dividend aristocrat, but every little helps.

SMT is too risky for me today

Despite the difficulties of the last 12 months, I would still be sitting on a decent gain, and probably wouldn’t sell Scottish Mortgage shares if I held them. Instead, I would hold back and wait for the recovery.

What should I do as a newbie? Should I buy them or are there better opportunities out there? During the summer bear market rally, Scottish Mortgage shares immediately picked up. I would expect them to do so again, when we see a more enduring recovery.

The trust remains an aggressive play on US technology, with Tesla its second biggest holding at 6.80% of the portfolio, just behind vaccine maker Moderna at 6.90%. Other top 10 holdings include biotech firm Illumina and battery business Northvolt, as well as Space Exploration Technologies, Amazon, and Tencent.

Clearly, this remains a high risk, high conviction fund. It boomed during the era of cheap money, as investors chased growth at any price, but those days are over. Today, my focus is now on buying dividend shares that have been undervalued by the market for too long. I prefer them to riskier growth stocks, given current economic certainties. That’s why I wouldn’t buy Scottish Mortgage today.

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Harvey Jones doesn’t hold any of the shares mentioned in this article. 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.

This is such a good time to go shopping for cheap dividend shares that I haven’t paid much attention to FTSE 100 growth stocks lately. So I was surprised to see how well BAE Systems (LSE: BA) has performed.

The defence manufacturer is up 34.52% in the past 12 months. That compares to a drop of 4.13% on the FTSE 100 as a whole over the same period.

BAE also outperformed over five years, growing 29.78%, while the index has fallen 7.95% over the same period. It’s thriving in tough times.

Beating the market

A quick glance at how the company describes itself explains why. “We design, manufacture, upgrade, and support combat vehicles and provide ammunition, precision munitions, artillery systems and missile launchers to a global customer base.”

Defence is arguably the number one defensive sector in our warlike times. Sadly, artillery, missiles and munitions are going to be in demand for some time. 

In August, BAE reported an 8.2% increase in half-yearly underlying earnings before interest and tax to £1.11bn, as its customers committed to increased defence spending. It also announced a £1.5bn share buyback.

Its earnings look set to rise even higher as the US, Europe and Asia boost defence spending to address what chief executive Charles Woodburn calls “the elevated threat environment”. JPMorgan Cazenove is now predicting around 10% earnings per share growth a year to 2025 and most likely beyond, with “quite low” risk. That’s impressive, given the harsh headwinds facing so many top UK companies at the moment.

BAE Systems also boasts a fully funded UK pension scheme, solid growth across all five divisions and a £52.7bn order pipeline. Free cash flow is solid and it pays out 50% of profits as dividends.

The FTSE 100 is packed with dividend stocks offering incredible yields, which make BAE Systems’ 3.3% forecast yield look modest by comparison. It’s nicely covered twice by earnings though.

Boom time for BAE

Perhaps the biggest surprise is that this £25bn company trades at a relatively inexpensive 14.8 times forward earnings. There are much cheaper stocks on the FTSE 100, of course. Some are available at five times earnings or less, but few enjoy as many tailwinds as BAE Systems.

As with any stock, there are risks (although unfortunately for the world, peace breaking out any time soon isn’t one of them). Servicing its £3.1bn net debt will get pricier as interest rates rise. Another danger is that markets may decide the BAE Systems share price has flown too high. If inflation falls and central bankers start easing, investors could make a tactical shift to recovery stocks.

I’m already there. While I think BAE Systems is arguably today’s best FTSE 100 growth stock, my current strategy is to buy dividend stocks as they’re available at rock bottom valuations right now. I prefer to buy stocks when they’re down, rather than when they’re up. So I might wait until BAE has fallen out of favour again. I accept that could take some years.

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Harvey Jones doesn’t hold any of the shares mentioned in this article. 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.