UK GROWTH VERSUS UK VALUE (PRICE-TO-EARNINGS VALUATIONS)
MSCI UK Growth / MSCI UK Value
Average
Source: Schroders, Thomson Reuters Datastream, data from 27 September 2013 to 27 August 2019. CS2242
distortion resulting from the loose monetary policy of the last decade has been the outperformance of growth stocks versus “value” stocks. Growth has become an increasingly soughtafter commodity and as a result more highly priced. The chart above shows the huge valuation premium that such stocks trade on in the UK, relative to value stocks. Value stocks tend to trade at a lower price relative to their fundamentals such as earnings or revenues. A group of shares can rise simply because investors view them more favourably, without any corresponding change in near-term prospects. Collectively, investors ascribe a higher value to the group. The chart illustrates how UK growth stocks are being ascribed a high value relative to value stocks. It compares the price-to-earnings ratio (a commonly-used valuation metric) of these two groups. On this basis, growth stocks are being valued almost twice as highly as value stocks, which is significantly above the average valuation premium shown by the green line. However, these distortions will not last forever. If monetary policy has indeed been stretched to its limits, then fiscal policy and economic restructuring will likely be turned to in order to lift economic activity. Financial markets may see this as a
trigger for rising inflation and higher interest rates. This would likely be supportive to the outperformance of lowly-valued value stocks over their growth counterparts. Bias towards more lowly-valued stocks A resolution of the Brexit stalemate may also be positive for UK value stocks. These include domestic banks, property companies, housebuilders, consumer discretionary areas (general retailers and leisure companies), food retailers, media agencies and utilities. Accordingly, we have a slight bias towards more lowly-valued stocks at the moment, where we can still find equities that are not priced for perfection. It is not certain that the UK general election on 12 December will help break the Brexit stalemate. But in any event, as a stock picker I embrace mispriced opportunities which arise during such periods of uncertainty (for details, see Why as an investor I’m looking through Brexit fears). Private equity (PE) and PEbacked buyers are finding a disproportionate amount of opportunities in the UK. There has also been an ongoing stream of bids from overseas businesses for UKquoted companies. For a detailed explanation of these trends see: Who’s buying UK shares and what
does it tell us?). At a time when the majority of the market is uninterested in UK equities, we share the opinion of these other large and experienced long-term investors and recognise the valuation opportunities. UK small and mid-cap (SMID) shares have outperformed other areas of the stock market over the long term. We expect this trend to continue. The recent pick-up in UK mergers and acquisitions (M&A, the buying, selling or combining of companies) is particularly focussed on SMID companies. In the past they have attracted a relatively greater part of the M&A pie, a trend that shows little signs of changing (see chart on next page). In a rapidly-evolving world, SMID companies are generally better able to capitalise on new opportunities as they tend to be more dynamic, and