Ed Legget of Artemis explains why even a modest reallocation of global capital towards the UK could trigger a dramatic re-rating of one of the world’s cheapest stockmarkets.
In recent months, a growing number of market commentators have been arguing that investors ought to increase their allocation to UK equities. And here’s why we agree:
- The UK’s listed companies currently trade on an undeservedly wide discount to their peers in every other major global market.
- The US trades on a forward price-to-earnings multiple of 21.6x compared to just 11.7x for the UK. (The Artemis UK Select portfolio, meanwhile, trades on a multiple of just 9x.)1
- The outlook for the UK’s economy is improving just as growth elsewhere appears to be weakening.
- The general election restored a degree of political stability to the UK that has been largely absent since the Brexit vote in 2016.
- While they wait for UK stocks to be-rated, investors are being paid to be patient. Some sectors, such as banks, are currently generating double-digit distribution yields (the cash companies return to their shareholders through share buybacks and dividends).
Source: Goldman Sachs as at 17 August 2024
Clients often ask us why UK shares won’t simply continue to trade on this historically wide discount indefinitely? And – if not – what will cause it to narrow?
We’re already seeing two significant forms of buying unfolding in the UK – share buybacks and M&A. It is, however, a third form of buying – inflows from overseas investors – that we think will prove to be decisive in narrowing the UK discount.
1. Companies are trying to close the ‘UK discount’ by buying back their shares or moving their primary listings to the US
Depending on the sector you’re looking at, UK companies trade on a 15% to 50% discount to their US peers. Rather than waiting for the market to arbitrage that discount away, they are, increasingly, taking matters into their own hands.
One result is that share buybacks in the UK are running at a c.£40 billion annualised rate, largely focused on the financials and energy sectors. One of Artemis UK Select’s largest holdings, NatWest, has reduced its share count by 30% since 2020. More recently, Vistry and WH Smith have become the latest holdings in our portfolio to announce buybacks.
Source: Bloomberg, Artemis as at 31 August 2024. Share counts rebased to 100 on 31 December 2020
The other way companies are actively working to close the UK valuation gap is by relisting their shares, often in the US, where they can tap into a bigger pool of liquidity and instantly be awarded significantly higher valuation multiples. Earlier this year we voted in favour of a proposal by one our holdings, Flutter, to move its primary listing to New York. Other recent re-listings include:
- CRH
- Indivior
- TUI
- Ferguson
More companies are considering joining them. In contrast to tracker funds, we aren’t obliged to sell our holdings the moment they no longer qualify for the FTSE. So, we tend to hang onto them when they relist to benefit from the uplift in their valuation multiples.
2. M&A is the second channel through which capital is targeting the UK discount
It is a truism that fund flows tend to follow performance, particularly in an era in which passive investment is increasingly dominant. Up to this point, the combination of rising earnings, double-digit cash returns and modest valuation multiples offered by UK plc, has not been enough to attract fund buyers.
Corporates, however, look at things differently. And, when they run their slide rule across UK listed companies, they see an opportunity to acquire their long-term earnings streams for a song. As a result, we have seen over US$56 billion of deals in the UK market over the year to date2. Combine these deals with buybacks and re-listings and around 6% of the UK’s market cap will be retired this year…
3. Fund flows from overseas will be the decisive factor in closing the UK discount
Source: EPFR, Goldman Sachs Global Investment Research
