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I FTSE 100 it is full of excellent stocks for investors to choose from. Some seem so cheap, in fact, that they can be considered ‘dumb’ stocks to buy.
But value investing can also create traps for stock pickers to navigate.
We all like stocks with low valuation metrics such as price-to-earnings (P/E) ratio or price-to-book (P/B) ratio. But some companies are cheap for a reason and face problems such as weak management, increased competition, industrial decline, high debt, and regulatory issues.
Dangerous place
Lloyds (LSE:LLOY) is a Footsie stock that consistently ranks near the top of the list of ‘most bought’ stocks among retail investors. This is due in part to the excellent value it offers on paper.
In fact, it looks like one of these purchases I’m talking about.
The bank’s P/E ratio is 8 times, and it sports a dividend yield of 6.4%. On top of this, its P/B ratio is 0.8. Any reading below 1 means the stock is trading at a discount to the stock price.
However, I believe that Lloyds’ low rating reflects the high level of risk it poses to investors. Its brand strength makes it one of the most popular banks on the high street. But it is also facing a nasty combination of poor loan growth and a painful credit crunch as the UK economy struggles.
Other risks include increased competition from rival banks, erosion of margins as interest rates fall, and potentially hefty fines if found guilty of illegal car lending.
Many of these issues mean Lloyds’ share price has fallen to its lowest single-digit percentage since 2009. So although it is provided with a strong dividend yield during that period, its average annual return during that time horizon is approximately 2.2%.
This is well below the FTSE 100’s long-term average of 7%.
A better deal?
Legal & General (LSE:LGEN) is another popular FTSE 100 share today. This may be due to its cheapness following the fall in share price in 2024.
The financial services giant’s P/E ratio is only 10 times. paid a dividend of 9.2 %.
Finally, its price-to-earnings growth (PEG) reading remains below the 1 value watermark, at 0.4.
But unlike Lloyds, I think Legal & General is a good deal to consider buying. That’s despite earnings being vulnerable to high levels of market competition.
It is my opinion that the potential rewards of owning shares in Legal & General outweigh the risks. It has great potential to increase sales amid demographic changes and growing interest in financial planning.
The outlook for the bulk money market is particularly bright, although other lines such as life insurance, pensions and asset management also have significant growth potential.
Smart brand strength and financial strength mean that Legal & General is well positioned to seize this opportunity. A Solvency II ratio of 223% gives you plenty of investment power to grow.
Invest £500 today
A mix of healthy share price gains and large dividends means Legal & General’s shares have delivered an annualized return of 11.6%. That’s well above the long-term average of 7% for Footsie shares.
Past performance is no guarantee of future returns. But if Legal & General can continue with that excellent plan, an investment of £500 today – and another £500 investment in another 15 years – could eventually turn into £240,514.
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