15 Mar 2024
A favourite bedtime story for my son is Eric Carle’s The Very Hungry Caterpillar. The larvae eats its way through many fruits and sugary treats day by day, before blooming into a beautiful butterfly. Given my son’s tendency to eat all snacks placed in front of him, I sometimes wonder if the story’s words are in fact a memoir of his day! This theme of sluggish growth before gorging its way to beauty is somewhat reminiscent of the current UK equity market.
The FTSE All-Share in aggregate has grown earnings per share (EPS) by 46% since the previous index high in May 2018. Over the same period, at the index level, EPS growth in US has been an impressive but not wildly superior 56%, Europe grew 54% and Japan by a measly 26%. Yet despite the UK keeping pace, the market has de-rated close to a 10-year low, whilst other major markets, particularly US, trade at much sturdier valuations.
Missing a blooming industry
Source: Bloomberg, 10 years to 31/12/2023
Private equity is taking notice of this valuation anomaly and deploying capital into the UK market, as rarely a week goes by without a UK listed company being acquired. Over the past five years, there have been more than 270 takeovers, at an average premium at 45% higher than undisturbed share prices. Put differently, private markets and overseas companies seem to be rating UK PLC at a much higher valuation than other investors. Indeed, two investment trusts held within our own portfolios were taken private during 2023 at 45% and 67% premiums. When companies generate cash flow from their operations, management have a decision to make on capital allocation: pay dividends, paydown debt, invest in growth capital expenditure or acquire other businesses. Dividends have been a historical preference for UK PLC versus international peers (the merits of this can perhaps be debated).
An alternative to the above listed capital allocation decisions, corporate CEOs and boards can spend the profits of the company buying back shares from investors – this can be particularly potent when company shares are lowly valued. We recently met with Redwheel UK Equity Income and Temple Bar Investment Trust managers, Nick Purves and Ian Lance, who quoted some staggering data.
.png)
Source: Redwheel, 29/02/2024
The above list shows that a slug of UK corporates are using surplus cash to buyback a huge chunk of their own shares. For example, NatWest has announced over the past two years that it has shrunk (or it will shrink) its share count by 29%. So long as group profitability remains constant, a proportionally higher amount of cash flow and dividends are available to remaining investors. The energy majors too are returning enormous amounts of capital to shareholders, an industry hamstrung on growth capex in non-renewable assets. In the case of BP and Shell, they are buying back 17% of their own market capitalisation. The UK market is quite simply eating itself! We can see similar patterns within (and advocate in favour of) our own investment trust holdings, such as in renewable asset owner Greencoat UK Wind, now paying dividends as well as investing their excess cash into the existing portfolio – i.e. buying back shares – rather than solely to fund additional investments.
The key missing piece of the puzzle is acknowledging future earnings growth. A rational investor should be willing to pay more for a company today whose earnings can grow at a faster rate in the future. Of course, the UK market lacks anything like the revenue growth of NVIDIA (thank Cambridge-based ARM’s NASDAQ listing for that!) However, investors should take note that long run EPS growth forecasts for the technology sector more broadly are now approaching the year 2000 levels – potentially justified in a new artificial intelligence paradigm, but every nonetheless, given the following bear market post year 2000.
Yet who would have thought one of the last decade’s problem children could outshine AI’s hysteria? NVIDIA’s 65% share price run over two years to year-end was dwarfed by Italy’s second largest bank Unicredit’s 95% total return1. Of course, a beneficiary of rising interest rates, but performance in part turbocharged by its large share buyback programme. Somewhat old-economy stocks – banks and energy – are using more modern capital allocation policies to try to drive share price returns for investors, even if that is yet to be recognised in the UK market. Buying back shares may lack the excitement of layering growth expectations, but it’s a low-risk and accretive investment for steady but undervalued business. When choosing my son’s bedtime story to read, it’s a sleep-at-night strategy which is all that is needed.
1Bloomberg data: NVIDIA +65% TSR, Unicredit +95% TSR, 31/12/2021 to 31/12/2023
Important information
For marketing purposes.
This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.
In the UK: Issued by Threadneedle Asset Management Limited, registered in England and Wales, No. 573204. Registered Office: Cannon Place, 78 Cannon Street, London EC4N 6AG. Authorised and regulated in the UK by the Financial Conduct Authority.
In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.
In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.
In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.
Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.