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The 2022 stock market correction profoundly impacted many UK stocks, including those within the FTSE 100. The index overall seems to have recovered from most of the damage.
Yet not all of its constituents have made a complete comeback, including those who seem to be resisting the economic turmoil plaguing the markets.
Combining weak investor sentiment with depressed valuations is often a recipe for bargain buying opportunities. And considering the stock market has recovered from every crash and correction throughout history, now could be the right time to snag some undervalued FTSE 100 stocks.
Focus on quality businesses
The lead index is home to the largest businesses listed on the London Stock Exchange. But size doesn’t always indicate quality. The stock market may have a perfect track record of recovering from economic downturns. Yet there have been and will continue to be countless enterprises that ultimately fail – even the big ones.
In other words, simply buying all the FTSE 100 stocks which have fallen the most in the last 12 months is likely a losing strategy. Investors need to dig deeper and discover why the share price has dropped.
Short-term disruptions to earnings are less concerning than an overleverage balance sheet in a rising interest rate environment. Similarly, if the business model has become disrupted or compromised, the depressed valuation may be justified.
But picking winning stocks isn’t just about the financials. A company with no discernible competitive advantages is unlikely to deliver ground-breaking, long-term returns. After all, if there’s no defence against rival firms or disruptive start-ups, holding onto market share will likely be a fruitless struggle.
Even something as simple as a well-known brand can be pretty powerful. Brands with a reputation for quality often command pricing power. So much so that customers may still be willing to pay a premium even when budgets are tight.
The best cheap stocks still have risks
Even if investors identify the best high-quality bargains within the FTSE 100 today, investment returns are never guaranteed. In fact, it’s entirely possible that buying top-notch shares right now could result in a loss. At least temporarily.
Don’t forget that the stock market is driven by mood and momentum in the short term. And considering investor sentiment is understandably weak right now, a top-notch enterprise may see its stock price slashed for no real reason beyond general market fear.
Stomaching that volatility is far easier said than done, especially if an individual begins to doubt their investment thesis. All too often, investors sell terrific shares at terrible prices, only to watch them rise again a few months later.
That’s why careful and confident analysis is critical to picking winning FTSE 100 stocks in the current market environment. And deploying strategies such as diversification and pound-cost averaging can help mitigate the risks of doing so.
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