‘Cheap’ UK equities a hunting ground for bargain seekers

For much of the past four years, the UK has been unloved, under-owned and undervalued. Brexit, COVID-19 and out of favour sectors have all conspired against UK equities, which have underperformed their developed market counterparts by around 30%.¹

For those with an eye for a bargain, however, the extent of that underperformance now makes the UK an attractive hunting ground. As a result, the UK has seen a significant increase in Mergers & Acquisitions (M&A) activity, with more than 20 takeover approaches worth in excess of £24bn since July 2020,² including prominent names such as William Hill and TalkTalk.

Why an upturn in takeover approaches?

Quite simply, the UK stock market offers domestic and internationally derived profit and cash generation at a discount to other international stock markets. This discount is true even after adjusting for the sector weightings of the UK market.

Since the outcome of the Brexit referendum result in 2016, UK valuations have de-rated relative to regions such as the US. On a P/E basis, UK shares are cheaper compared to their American counterparts than at any time since the creation of the FTSE 100 with previous troughs followed by sustained outperformance, such witnessed after the Global Financial Crisis or the bursting of the dotcom bubble.

The plethora of M&A deals is a clear signal that people are beginning to take advantage of the opportunity in the UK. For activist investors, private equity and corporate buyers, the UK represents a kind of carry trade, with cheap money raised to buy undervalued companies.

Money waiting on the sidelines

If sentiment towards the UK does start to shift more widely, there is plenty of capital ready to flow back into UK shares. A Bank of America Merrill Lynch survey in July 2019 said 23% of global investors were underweight UK equities, despite the clear valuation opportunity at that time.³  Since this date, the UK market has become comparatively cheaper and ownership has declined further.

Today, UK equities face two near-term catalysts for outperformance – a deal with the EU and a vaccine rollout which would provide clarity on when leisure venues like pubs or restaurants can begin operating more normally. Once this happens, far more investors will want a piece of the UK, driving up the market in the process and creating a virtuous circle as investors start to allocate back to the UK. As the old saying goes, there’s nothing like price to improve sentiment.

How long will UK equities remain cheap?

We don’t expect this valuation discrepancy to last forever. Equity strategists are starting to take note of the M&A activity, together with the valuation anomaly. While many investors may still be wary on the UK, we remain excited about the opportunity set available, particularly given the additional benefits of world leading corporate governance, dependable contract law and title law and company management teams that are permanently accessible.