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I think value investors looking for stocks to consider buying could do much worse than 3i (LSE:III). is the highest performing FTSE 100 stock from the last five years, but it doesn't seem very expensive.
Despite its stellar performance, the stock trades at a below-average price-to-earnings (P/E) multiple. And while there is more to it than this, it is a really interesting business with a lot to offer.
What does 3i do?
3i is a private equity firm. But what sets it apart from its competitors is that it focuses on investing its own capital, rather than that of its clients.
This gives you a great advantage. In the private equity sector, clients are often (and understandably) more enthusiastic about putting their money to work when they see things going in the right direction.
The problem is that is when stock prices are high. The best time to invest is when prices are lowest, but there is usually less enthusiasm for buying stocks when prices seem to be falling day after day.
Investing its own capital gives 3i the ability to take advantage of opportunities when they arise. And I think this is the key reason why the stock has outperformed the FTSE 100 so consistently in the past.
Valuation
The valuation of 3i is a bit complicated. The AP/E ratio of around eight seems like a relative bargain, but savvy value investors will know that there is much more to consider than this.
The company's earnings can be volatile, meaning the P/E multiple can sometimes be misleading. A good example is 2020, when the Covid-19 pandemic caused earnings to fall and the P/E ratio to rise.
3i earnings per share vs. P/E ratio 2014-2024
Created in TradingView
In this situation, considering the price-to-book (P/B) multiple can give a better idea of where the stock is trading. And 3i stock is currently trading toward the upper end of its recent range.
P/B Ratio 3i 2014-2024
Created in TradingView
This is something investors should consider. While the stock looks cheap on a price/earnings basis, I think there's a good argument to conclude that it's actually unusually expensive, and this creates a risk.
Opportunities
When stocks trade at unusually high multiples, it's a sign that investors expect strong growth. In the case of private equity, this means finding ways to increase the return on your investments.
A large part of 3i's portfolio is occupied by an investment in a European discount retailer called Action. And this has been a source of strong growth in the past.
However, this can lead to a relatively concentrated portfolio, and this is a potential risk. Investors might well think that a diversified portfolio could provide more stability over time.
3i, however, has been relatively inactive in terms of new investments for some time. However, sooner or later, the company's continued growth will depend on it finding opportunities to expand its portfolio.
silly takeaway
I think there are many good reasons to consider buying 3i stock. The main one is its differentiated business model that allows it to take advantage of cyclical opportunities as they arise.
However, investors should not be fooled into thinking that a P/E multiple of eight means the stock is cheap; In fact, it is unusually expensive. It may still be a good investment, but it needs careful analysis.
