While economic uncertainty continues to plague businesses, conditions are slowly improving, allowing for what appears to be the start of a market rally for many cheap shares.
The FTSE 100 is up by nearly 10% since October, with the FTSE 250 sitting slightly ahead as growth stocks make a comeback.
However, even with this recovery progress, there remain plenty of cheap shares available across the FTSE 350. And as every investor knows, buying at low prices paves the way for higher potential capital gains and dividend yields.
Therefore, now could be the right time to start investing. For those with £500, or any other amount, to invest each month into a diversified range of high-quality companies, it’s possible to potentially unlock market-beating returns for the coming years as the stock market rally accelerates.
Finding bargains in 2023
There are plenty of cheap shares on the London Stock Exchange today. After all, the stock market correction in 2022 sent countless valuations into a tailspin.
But just because a share price is under £5, that doesn’t necessarily mean the stock is cheap. In fact, it could be wildly expensive in relation to the underlying business. So how can investors identify bargains in 2023?
Estimating the intrinsic value of a firm is challenging, with different investors taking differing approaches. However, in most cases, valuation is based on a collection of factors, including future prospects, profitability, growth, and the value of existing assets.
The most popular and easy method is by using the P/E ratio. Alone it doesn’t say much. However, by comparing the metric against historical and industry averages, investors can determine whether the shares look cheap.
Stocks trading at a low P/E Ratio could be operating in a challenging environment resulting in a difficult outlook. Or perhaps, the balance sheet is in a weakened state on the back of rising interest rates. However, for some high-quality companies in 2023, the low valuations are being caused by weak investor sentiment. And these are the firms primed to thrive in the coming stock market rally.
Rallies don’t happen overnight
The economic situation in the UK might be improving. But there remains a lot of progress required before things can return to pre-inflationary conditions. And during that time, plenty of things can go wrong.
For example, if the Bank of England is too aggressive in its strategy to fight inflation, the pressure on consumers could trigger a recession, sending shares spiralling. Needless to say, this could rapidly undo the progress made so far this year and delay the eventual stock market rally for some time.
But even if a recession is avoided, cheap shares aren’t going to magically surge overnight. It takes time for investors to regain confidence. As such, a rally could extend across many months, or even years. And for those who lack patience, selling too early could severely undercut the return potential of a well-positioned investment portfolio.
Nevertheless, buying and holding top-notch cheap shares for the long run is a proven strategy for building enormous wealth in the stock market. And it’s precisely how investors like Warren Buffett have built their fortunes.
