The stock market has been on a tear over the past eight months, with inflation steadily falling and investor sentiment much better than it was at the start of 2022. And with that, UK shares are trending higher across the board.
From October 2023 onwards, FTSE 250has surged by over 25% including dividends! This puts the company firmly back in bull market territory. Similarly, flagship stocks FTSE 100has also increased by double digits, FTSE All Share Let’s ride together.
But despite this impressive growth, many UK shares are still trading well below their pre-inflation prices, so assuming the recent stock market momentum continues, it may not be long before these cheap stocks start delivering impressive results.
Take advantage of discounted prices
2022 was the year investors had to endure the first extended valuation decline in over a decade, because such an event is actually very rare. There are always buying opportunities available. But it is exceptional that such a wide range of options are available at the same time.
But not all of these “cheap” stocks are actually bargains — some may never recover to their previous highs — so simply buying up stocks on sale is likely to end up destroying wealth rather than creating it.
Instead, investors need to exercise discipline and diligence when selecting companies for their portfolios. This is especially true when considering smaller companies.
A market downturn may only be a temporary headwind, but it can become a permanent threat if a company does not have the financial resources to weather the storm. Similarly, companies that fail to protect themselves with competitive bulwarks may lose market share to other companies and see their performance decline.
With that in mind, investors need to look beyond stock market conditions when determining why stocks have plummeted — that way, it’ll be much easier to identify the traps.
What are the best stocks to buy today?
Among the cheapest stocks in the FTSE 100 Centrica (LSE:CNA) stands out right now. The energy and utilities business is benefiting greatly from rising energy prices. But the company’s price-to-earnings (P/E) ratio is just 2.0, compared to a market average of 10. Sure, on the surface it sounds like a great bargain, but is it a trap?
It is important to highlight that the company had a number of non-recurring revenue streams in 2023. As a result, the P/E ratio is currently tilted downwards. Therefore, it is more appropriate to use the forward P/E ratio, which increases the metric to 7.0. While this still looks relatively cheap, it is clear that this business is not as much of a bargain as is being suggested.
In the short term, things are looking up for the company – and most analysts tracking the stock have an average 12-month target price of 170p, about 27% above today’s price – but in the longer term, there may be more uncertainty.
Many British homes are switching from gas boilers to heat pumps, an area Centrica is involved in, but it represents a relatively small part of its business, meaning that in the long term it could see smaller competitors move in and monopolise market share.
The article A huge stock market recovery is underway! originally appeared on The Motley Fool UK.
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Zaven Boyrazian has no investment position in any of the stocks mentioned. The Motley Fool UK has no investment position in any of the stocks mentioned. Views expressed on companies mentioned in this article are those of the author and may differ from official recommendations we make in subscription services such as Share Advisor, Hidden Winners or Pro. At The Motley Fool we believe considering diverse insights makes us better investors.
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