Could I build my wealth by buying gold and hoping its price rises? Perhaps. But I am not doing that. Gold is not a productive asset. Instead, if I wanted to build my wealth from scratch right now, I would start investing in quality companies selling at cheap prices. Let me explain the elements of that approach in turn.
Building wealth from scratch
To increase financial resources from a standing start by buying shares, several things need to happen.
First, I need to put money into buying those shares. That could be a lump sum upfront, or I might drip-feed money in on a regular basis. But one way or another, I will need to have some funds to invest.
Secondly, I need to buy shares that grow in value, pay me dividends, or both. Over time, that is what could hopefully help me grow wealth from the money I invest.
Investing in high-quality companies
So should I buy a share just because I think its price will keep rising or the dividend yield is high?
I would not do that. A share is a small piece of a business. I prefer to buy or sell based on what I expect the long-term performance of that business to be, not merely the momentum I see in share price movements.
As for dividend yield, if a business becomes less successful it may no longer be able to afford to pay that dividend. So, again, my focus is on the quality of the business and how I expect it to do in coming years and decades.
Buying cheap shares
But like a quality car or dream holiday, paying too much even for something attractive can mean it is no bargain. If I overpay for a share, it may turn out to be a poor investment, even though the company has strong prospects.
That is why I focus on valuation when buying a share. Take FTSE 100 engineer Spirax-Sarco as an example. I think it has an excellent business with strong prospects. But I would not buy shares in the firm for my portfolio at their current price.
With a price-to-earnings (P/E) ratio of 37, the shares look expensive to me. They have fallen 23% in the past year, even though the firm’s most recent annual results recorded basic earnings per share soaring 35% and the dividend increasing for the 54th year in a row, this time by 15%.
Instead, I would rather buy shares in great companies that trade at what I think are compelling prices. That strikes me as one way I can seek to build my wealth.
For example, retailer B&M has a P/E ratio of 11, making it much more competitively valued on that metric than Spirax-Sarco. Admittedly, its recent business performance has been less impressive than the engineer. But I see B&M’s strong brand, large customer base and retail experience as key growth drivers. Revenues in the most recent quarter grew 12.3% compared to the same period last year.
If I had spare cash and had never bought shares before, I would start investing in firms like B&M that I felt combined excellent business prospects with an attractive valuation.
The post Forget gold! I’d start investing in dirt-cheap FTSE 100 shares to build wealth appeared first on The Motley Fool UK.
C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended B&M European Value. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2023