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It’s no secret that FTSE stocks are cheap and have been for a good while now. Finally, investment banks have started to take this seriously, as evidenced by the 11% rise in the FTSE 100 over the past six months.
On May 20, HSBC joined a growing chorus of voices. It upgraded British stocks to ‘overweight’ from ‘neutral’. This means it is recommending that its clients increase their investments in UK shares.
And it raised its target price for the FTSE 100 from 8,100 to 8,750, which would be 6% higher than the current level of 8,235.
Why has HSBC turned bullish?
The investment bank cited a myriad of reasons for this upgrade.
First, it noted that the FTSE 350 index is cheap relative to its historical levels and other markets. In fact, it calculated that London’s discount to New York is currently 23% wider than usual.
This could lead to more mergers and acquisitions.
Second, it argued that higher commodity prices (benefitting FTSE miners), along with US dollar strength (benefitting global firms), are boosts for performance.
Third, FTSE dividend yields and share buybacks “outstrip” other markets.
Finally, the analysts said that “the long-term structural overhang of UK pension fund selling is at an end; they simply have no more UK equities left to sell”.
This last point is an interesting one. UK pension and insurance funds have cut their exposure to UK shares from 53% in 1997 to just 4.2% today.
Collectively, institutional investors have pulled an estimated £1.9trn from the London Stock Exchange over the past three decades, according to HSBC.
But how large can these remaining holdings be? Surely we’re nearing a bottom in the mass selling!
What to do?
Essentially, there are two ways to approach this. Firstly, I could just buy a broad-based FTSE 350 tracker fund to try to capture this potential value.
That is, I could buy the entire haystack rather than trying to find the needles in it, to paraphrase index fund pioneer John Bogle.
Or I could try to find individual opportunities by focusing on undervalued stocks that I think might offer better long-term returns. This is how I’m approaching things with my own portfolio.
A titanic yield
For me, a FTSE 100 stock that epitomises deep value is British American Tobacco (LSE: BATS).
It is trading on a forward price-to-earnings (P/E) ratio of 6.5. That’s a wide discount to its historical and peer group average.
Indeed, US rival Philip Morris International is trading on a forward P/E multiple of 16.1!
Then there is a monster 9.8% dividend yield, while the firm has also committed £700m to buying back its own shares in 2024, then £900m for 2025. This programme is fully funded by a part disposal in India’s ITC.
Of course, due to ethical considerations, pension funds aren’t ever likely to start piling back into tobacco stocks. But I suspect most of the heavy institutional selling might be over.
As always, the main risk here is declining overall cigarette volumes, which could hit profits in the coming years.
Nevertheless, by 2026, the company still expects to achieve 3%-5% growth in organic revenue, while growing underlying operating profit in the mid-single digits.
I’ve been buying the stock for its near-10% yield in a bid to boost my passive income.
