Recent pessimism on "UK plc" has been relentless, which naturally roused the contrarian in me. In order to locate any potential green shoots, I made the decision to examine the corporate UK environment from a different angle. I looked deep into JPMorgan and AJ Bell's assessments and discovered three key causes for confidence in the biggest corporations in Britain. This is them...
1. They have an impressively low forward P/E.
The stocks of the nation seem to be priced favorably from a valuation standpoint. The price-to-earnings ratio for the MSCI UK index, which is calculated using projected profits, has dropped to a historic low when compared to the MSCI World index. Furthermore, as you can see from the chart, it has now dropped well below two standard deviations from its average, or "mean" level, and is currently trading at a 40% discount. The likelihood that the price will "mean reversion," or return to its long-term average, rises as a result of this large variance.
MSCI UK’s 12-month ahead P/E divided by the MSCI World 12-month forward P/E. The mean value is represented by a solid horizontal line, with dotted lines at +2 and -2 standard deviations. Sources: IBES and JPMorgan.
Although picking bottoms is impossible without a crystal ball, investing is a game where you can increase your chances of success. The value of the MSCI UK index is less likely to decline further at a forward P/E multiple of 8.6x. Let's face it: the UK index's forward P/E isn't just inexpensive when compared to its competitors; it's also inexpensive when compared to the past 20 years of the index.
2. They’ve got some nice-looking dividend yields.
The overall returns from shares are made up of two parts: yield from dividend payments and capital appreciation, which is the rise in stock valuation. The first one has already been explored, and when it comes to dividend yields, the UK once more shines out. The FTSE 100 offers investors a yield of 4.1%, which is significantly higher than that of shares from other advanced nations. And two considerations indicate that those yields will remain stable even as concerns about a recession and the earnings environment worsen. First off, the FTSE 100 earns 70% of its revenue abroad, and because of the depreciating value of the pound, returns of foreign profits are worth even more now. Second, the dividend payout ratio has already decreased significantly, reaching lows of about 50%, compared to its previous 70% peak.
Dividend yield across major developed markets. Sources: JPMorgan and IBES.
3. There are some strong prospects for buybacks and foreign acquisitions.
According to an AJ Bell research, business boards have chosen to repurchase their own shares at a cost of about £51 billion ($57 billion) this year due to the extremely low share values of many UK companies. And having a major market participant drive up the share price is not a bad thing when you're optimistic on stocks. A rise in foreign players acquiring UK businesses could be a result of such low share prices. You can get the checkbooks out when very low valuations and a weak pound are combined. In addition to the yield and valuation components, this could offer further profits.
So what’s the opportunity then?
In the game of investing, you'll never have a 100% probability of success, but the trick is to look for asymmetric possibilities, in which the upside price potential is greater than the downside possibility. This raises your chance of getting good results and gives you a margin of safety. Therefore, the FTSE 100 represents an attractive investment opportunity.
There are two ways you could play it. The first would be via a pairs trade, buying the undervalued FTSE 100 (the more multi-nationally focused index) and selling the relatively overvalued FTSE 250 (the more domestically focused index). In this way, you’re hedged, or market neutral, and can still make gains whether the market goes up, down or sideways. The second would be to invest in the FTSE 100 outright, perhaps by buying the iShares Core FTSE 100 UCITS ETF (ticker: ISF; expense ratio: 0.07%).
By zooming in and getting more specific on a sectoral level, UK homebuilders are trading for about 45% less than the FTSE 100. Given the size of that haircut, it would appear that the anticipated housing market fall and the overall unfavorable perception of the industry have already been largely factored in. It's vital to remember that this industry is also subject to predictions of interest rates from the Bank of England (BoE). Therefore, shares of homebuilders including Persimmon (PSN), Vistry Group (VTY), Crest Nicholson (CRST), and Barratt Developments may experience a strong increase if the BoE adopts fewer hikes than investors anticipate or if the housing market experiences a softer landing (BDEV).
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