Forget buy-to-let! I’d invest in cheap UK stocks to build wealth

In an effort to build wealth, some people consider buying property. They can be hugely rewarding, but being a landlord can also require a lot of hard work and often require large sums of money up front. My own approach, by contrast, is to invest in UK shares with whatever money I have. It doesn’t require a large amount of money to start, and it doesn’t require a lot of work to manage the property.

But how do I decide which stocks to buy?

Hunt for cheap UK stocks

What makes stocks cheap? Is it cheaper to sell in cash instead of pounds? Indefinite.

In the case of shares priced in pennies, yes, the price per share is cheaper. But cheapness about it value no price. A share may be worth £20, £20 or £50, but it is still good value based on the share it represents in the company’s future financial prospects. Conversely, selling shares for just a few bucks can still be overpriced when considering the long-term commercial prospects of the business.

So when I look for UK stocks that I can buy in the hope of building wealth, I look for ones that don’t match what I see as the company’s current share price and long-term value.

Apply theory

Let me show you an example. Now, stock at retailers J Sainsbury can be sold for 2.40 Euro. But knowing a company’s stock price is only part of understanding its value—investors also need to know how many shares are in circulation. Market capitalization is the stock price multiplied by the number of shares.

In the case of J Sainsbury, it is around £5.7bn. The retailer announced today that it expects full-year profits to come in at the top end of the £630m-£690m range. If the company earned £690m, the price-to-earnings (P/E) ratio would be 8. That seems cheap to me.

But a low P/E ratio does not necessarily indicate a low valuation. I also have to look at other factors, such as what debt the company has (it may not affect earnings, but it will have to be paid back at some point) and also whether the business seems likely to maintain or grow profits. Otherwise, the stock might be called a value trap. This is one that looks cheap but, as the business performance is declining, it may be a bad value.

Create a portfolio

Using this approach, I can try to build wealth by building a portfolio of UK stocks that I think offer good value. To do that, I will try to find companies that I think have good business prospects, not only for the short term but also in the longer term.

I will then consider whether the current stock price gives me great value. Otherwise, I wouldn’t do anything. But if the stock price is low enough that I feel like I’m getting great value, I’ll consider adding the stock to my portfolio.