Key insights
- UK stocks are for sale at significant discounts to the US, even if they earn revenues in international markets
- The CT UK Capital & Income Investment Trust receives more of its underlying revenues from the US and Europe than the UK
- Recognising the discount, there’s a boom in foreign acquisitions of UK companies
It’s a mysterious anomaly that UK shares are trading at super cheap prices, yet many of the companies behind them earn sizeable revenues overseas. Even if you assume the UK economy might be held back by the cost-of-living crisis and overhang from Brexit, the discount prices defy logic.
If a London Stock Exchange-listed company operates mainly in the United States, for example, it benefits from the same economic conditions as its peers trading on the New York or Nasdaq exchanges. Why then should its shares trade at a substantially lower valuation?
Expert investors are always on the lookout for investment opportunities like this, and it’s one that’s embedded in the CT UK Capital & Income Investment Trust’s portfolio. The trust owns many companies with extensive businesses in the United States or Europe that are trading at UK stock market valuations.
“Most of the stocks in the portfolio are listed in the UK,” notes Julian Cane, the Fund Manager. “But the portfolio’s very different to the UK economy. Our exposure to the US and Europe is greater than that of the UK.”
Operating in overseas markets
What Julian means by this is that adding up the revenues of all the stocks owned by the trust shows that they earn more revenues in North America and Europe, taken together, than in the UK. This is accidental rather than intentional, but means they benefit from relatively robust US economic growth especially.
Yet the trust’s predominantly UK-listed holdings trade at significantly lower valuations than they would if they were listed on US stock exchanges. The price/earnings ratio — is a well-known measure that shows how much investors are willing to pay for a company’s profit —paints a clear picture.
Looking first at the United States, the US S&P 500 Index tracks the performance of 500 of the largest companies listed on US stock exchanges. It’s trading at a forward price-earnings-ratio of about 22 times¹. Historically, the ratio has averaged about 16 times, which shows that US stocks are trading at a significantly higher valuation than they have on average going back over time.
Turning to the UK, the FTSE 100 Index tracks 100 of the largest companies listed on the London Stock Exchange. It’s trading on a price-earnings-ratio of about 11 times², which is still below a historical average of roughly 12 times.
The FTSE 250 Index of 250 mid-sized companies — where the CT UK Capital & Income Investment Trust mainly invests — is even cheaper compared to its past: while the price-earnings-ratio is also at about 11, the index’s long-run average is closer to 14 times.
“The FTSE 100 largest companies are cheaply valued but the FTSE 250 companies are very cheap at their current rating at about 11 times,³” notes Julian.
Acquirers exploiting sale prices
What this means is that the businesses owned by the trust are making profits worth about 10% of their value each year. In another measure of value, the dividend yield on UK shares is between 3% and 4%, more than twice as much as the S&P 500 Index dividend yield.4
In a sign of the times, overseas acquirers are taking advantage of the discount prices. The value of bids for UK companies had reportedly reached more than $78bn for 2024 by May, according to Dealogic.5 That was the highest level since 2018 and included well-known companies like miner Anglo American and International Distributions Services, owner of the Royal Mail.
These acquirers are taking advantage of the illogical anomaly that puts UK companies on such a steep discount. It’s hard to know, though, what will narrow that discount, or even when it will happen. In the meantime, CT UK Capital & Income Investment Trust is taking advantage of the opportunity to buy high-quality companies at discount prices.
Investment risks
The value of your investments and any income from them can go down as well as up and you may not get back the original amount invested. Gearing is used for investment purposes to obtain, increase or reduce exposure to an asset, index or investment. The use of gearing can enhance returns to investors in a rising market, but if the market falls the losses may be greater.
The mention of a company does not constitute, and should not be construed as, investment advice or a recommendation to buy, sell or otherwise transact in the company.
1 Based on estimates for 2024 earnings to be reported in 2025. Source: wsj.com. 21 June 2024. https://www.wsj.com/market-data/stocks/peyields
2 The Times. April 27, 2024. The FTSE 100 is flying – is it time to buy UK stocks? https://www.thetimes.com/business-money/money/article/ftse-100-news-uk-stocks-best-how-ftse-100-british-isa-jrqwv5wnh
3 FTSE 250 price / earnings ratio updated as at April 2024. Will UK stocks finally catch a break? FT.com. https://www.ft.com/content/2ee303c7-4dbc-422e-9a3b-05a84a6c6058
4 The profits estimate and dividend yield are correct at the time of writing in June 2024.
5 Takeover interest in UK companies hits highest since 2018. Financial Times. May 12, 2024.
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