2023 was a great year to own stocks. The S&P 500 index of America's 500 biggest companies surged an above-average 17.5% last year, and after hitting a bit of a speed bump in the first week, has kept moving higher in the New Year -- up about 1% right now.
That sounds like good news, but it does come with a downside. At 26 times earnings, the S&P 500 index looks historically expensive. And compared to other stock markets around the world it is expensive. WorldPERatio.com calculates that America currently has the fourth most expensive stock market in the world. (No. 1 is New Zealand, if you're curious.)
But do you know who doesn't have an expensive stock market right now?
Britain, that's who.
Image source: Getty Images.
In fact, while the U.S. stock market polls at historically "expensive" compared to the last 10- and 20-year periods, the U.K. stock market appears cheap relative to just about any period you like: the last five years, the last 10 years, and the last 20 years as well. In fact, at a country-wide valuation of just over 10x earnings, the average British stock costs less than half as much as an equivalent American stock, when comparing price to earnings.
Three big British stocks in particular look like buys, based mostly on their supremely low P/E ratios and enormous dividend yields: British American Tobacco (BTI -1.26%), HSBC Holdings (HSBC -1.21%), and Vodafone Group (VOD -0.82%).
British American Tobacco
Let's start with British American Tobacco. As the name implies, BAT is one of the world's foremost manufacturers of tobacco products, owning a stable of brands ranging from Camel to Dunhill to Lucky Strike to Newport, as well as smokeless brands such as Kodiak chewing tobacco and Vuse e-cigarettes.
That's both a plus and a minus. For nicotine addicts, BAT offers many of the world's most famous brands. But it also makes BAT famous for purveying poisonous products, which are increasingly being banned or strictly regulated around the world.
On the other hand, it's hard to argue with success, and BAT is very successful at making money off of nicotine. With $11.1 billion in trailing-12-month profits, BAT sells for a cheap six times earnings -- and is even cheaper when valued on its free cash flow: It's priced at just five times FCF.
As regulations mount, BAT may struggle to grow going forward. That's the bad news. The good news is that BAT's monster 9.8% dividend yield more than covers the most pessimistic valuation I can get for the stock -- a debt-adjusted 10.3x earnings. Even if the stock grows no faster than the 4.3% long-term forecast assigned to it by S&P Global Market Intelligence, it still looks 22% undervalued to me.
HSBC Holdings
If tobacco investing isn't your thing, though, and you'd like to stick with something a bit less risky, perhaps a nice, conservative banking stock would suit? In that case, Britain's HSBC deserves a look.
Priced at a low, low five times trailing earnings, HSBC certainly looks cheap enough. True, based in the slow-growth U.K., HSBC probably isn't going to set the world on fire with its growth rate. Earnings that surged 78% in 2023 are expected to peak next year and then slowly decline over the next few years. But thanks to a generous dividend policy, HSBC doesn't actually need to grow earnings much to make this stock a winner for conservative investors.
While not quite as generous as British American Tobacco, HSBC still pays a tidy 7% in annual dividends.
Vodafone
Last, let's turn the spotlight on Vodafone, one of Europe's biggest cellphone service providers. This one's a bit trickier to value, mainly because of $10 billion in asset sales in 2023, which inflated its net profit without benefiting its operating profits much at all. (To the contrary, operating profits are now in their second straight year of decline.) But I think it's worth the effort.
The good news for Vodafone is that if you dig a little deeper into the company's financials, free cash flow at the company is a lot more consistent -- a lot less "lumpy" -- than reported net income. Over the last five years, Vodafone generated an average of $12.5 billion per year, just a rounding error away from the $12.3 billion it generated in cash profit over the last 12 months.
Yet the entire company has a market capitalization barely twice that -- only $23.1 billion. Now, don't make the mistake of thinking this company only costs "two times free cash flow." Vodafone isn't quite that cheap. Like most big telecoms, Vodafone carries a boatload of debt on top of its market cap, enough to raise its enterprise value to a much more substantial $82.3 billion.
Still, valued on free cash flow that's an EV/FCF of only 6.7x.
In my opinion, Vodafone's dividend yield alone -- a gigantic 11.5% -- more than justifies this valuation. Between the generous dividend and the cheap valuation, even if Vodafone does not grow at all over the next few years, this stock looks to me like the best bargain of the bunch.
HSBC Holdings is an advertising partner of The Ascent, a Motley Fool company. Rich Smith has no position in any of the stocks mentioned. The Motley Fool recommends British American Tobacco P.l.c., HSBC Holdings, and Vodafone Group Public and recommends the following options: long January 2024 $40 calls on British American Tobacco P.l.c., long January 2026 $40 calls on British American Tobacco P.l.c., and short January 2026 $40 puts on British American Tobacco P.l.c. The Motley Fool has a disclosure policy.
