Grounds for optimism in the UK stockmarket

19/02/2019

Last year is unlikely to be remembered fondly by many investors around the world, not least in the UK. In common with stockmarkets globally, London-listed shares suffered major price falls.

Glossary

For explanations of the investment terms used throughout this article.

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The UK stockmarket endured its worst annual performance since 2008, at the height of the financial crisis. Total returns, being capital growth and income combined, from the FTSE All-Share index of UK-listed company shares were minus 9.5% in 2018.

Paper losses of this order can look painful, but as investors we must remember that past performance, however recent, is no guide to future performance.

We should also remember to keep our long-term perspective. Even despite the desperately uncomfortable final few months of 2018, total returns from the FTSE All-Share index over the five years ending 31 January 2019 were 31.2%. This is an average return for investors of 5.6% a year.

Value potential

With so much uncertainty surrounding the impact of Brexit on companies and the wider economy, the road ahead is likely to be a little bumpy.

Nonetheless, it is important to recognise that a fair degree of bad news is baked in to UK share prices already. If it transpires that outcomes are better than expected, one might expect this implicit ‘Brexit discount’ to diminish and prices to correct.

Given the inherent uncertainties, it may be sensible to focus instead on the fundamental quality of assets and their value proposition. Price is a good place to start and, by some measures, UK shares look cheaper than those in most other global markets.

Comparing share prices to company earnings, the shares of the largest UK companies (according to the MSCI UK Index) were trading at an average price of 14 times their annual earnings, at the end of January 2019. For the world’s largest companies (as included in the MSCI All Country World Index), share prices were on average 17 times greater than earnings. In other words, UK companies look ‘cheaper’ on this measure than their global counterparts.

Income prospects

Meanwhile, UK-listed companies paid out record dividends to their shareholders in 2018. Larger profits led to a 5% rise compared to the previous year.

Higher dividends and lower share prices have combined to push up the dividend yield of the FTSE 100 index – reflecting annual dividends as a percentage of share prices – to their highest level in a decade.

Obviously, income distributions vary from company to company, but the dividend yield of the FTSE 100 as a whole – reflecting the shares of the largest UK-listed companies – was 4.5% at the end of January 2019. This is more than double the dividend yield of the S&P 500 index of the largest US stocks. At face value, UK shares therefore offer an income stream at half the price of their US counterparts.

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It is vital to remember that dividends are never guaranteed though, and can be reduced or cut altogether at any point by company management. Dividends are often trimmed when companies’ profits fall or if economic conditions are challenging.

Risks abound, but if profits remain resilient there could be plenty of upside for investors in UK shares. Indeed, many of the largest UK-listed companies derive most of their revenues from outside the UK, and in a range of currencies. This means their fortunes are not necessarily wedded to the fortunes of the domestic economy – and the value of the pound – in the way that those of smaller UK companies generally are.

Selective opportunities

Helpful as looking at an index can be, the value proposition of UK stocks – and the reliability of their future dividend payments – is unique to each. Companies can better be judged on their individual merits, and this is where we believe active fund managers can play an important role.

Our fund managers have the freedom to be selective as they invest in pursuit of their fund’s objective. Not only can they avoid those companies that they think are either overvalued or expect to face challenges, but they can invest in those they believe are undervalued or stand to benefit from opportunities or circumstances in the future.

The beauty of an active investment approach is that fund managers have the freedom to go against the grain to pursue opportunities where analysis uncovers them. When UK shares are out of favour with global investors, these opportunities are arguably even greater.

Remember, we are unable to give financial advice and these views should not be taken as any kind of recommendation or forecast. If you are unsure about the suitability of any investment, speak to your financial adviser.

Past performance is not a guide to future performance. The value of investments, and the income from them, will fluctuate. This will cause fund prices to fall as well as rise and you may not get back the original amount you invested.