Is the UK’s valuation discount a problem?

In April this year, UK stock markets hit record highs¹, prompting investors to view the region in a more positive light. But this hasn’t been enough to deter British household names from considering moving their listing from London in favour of New York. 

One of the reasons behind this is that valuations in the UK stock market have been under intense scrutiny. The stock market’s Price-to-Earnings (P/E) ratio, a barometer for valuation, has been trailing its US counterparts, resulting in business leaders’ reassessment of their company's listings. 

Listing in America appeals because UK companies like Diageo, British American Tobacco and Shell could see their value more than double² if they manage to trade on the same multiples as US peers like Brown Forman, Philip Morris and ExxonMobil.

Oil producer Shell, which frequently trades places with AstraZeneca as the largest company listed, by market capitalisation, on the UK stock market, has publicly courted the idea of switching to New York. Although a blow to UK investors, the move could offer Shell access to a more receptive market and deeper capital pool, which could boost its share price even further. Reports suggest that a US listing could see the company’s valuation increase by 28%³ if it’s rated the same as ExxonMobil by investors.

Referring to the valuation gap, Shell CEO Wael Sawan told Bloomberg, ‘If we work through the sprint, and we’re doing what we’re doing, and we still don’t see the gap is closing, we have to look at all options.’ A spokesperson for the company has made similar comments at several public events, adding that options could be explored as early as 2025. 

Another motivation behind the likes of Shell moving across the pond is that a UK listing may be damaging to company valuations. Factors such as Brexit and recent political instability have affected the domestic stock market's appeal to international investors. 

2022 was a particularly difficult year with the UK churning its way through three prime ministers and four chancellors, while fears of a recession dominated in 2023. 2024 and a comfortable Labour majority could offer some stability.  

These factors, along with the UK stock market’s limited exposure to the rallying technology sector, have all contributed to the UK becoming an unloved investment sector.

This has prompted the previous government to introduce plans for a British Individual Savings Account (ISA). However, this may not be introduced as the new Labour government didn’t mention this in their manifesto and they remain committed to simplifying the ISA market. As a result, investors are left to rely on the strategies UK companies implement to bolster growth and attract investment.   

It’s not only government that has attempted address the UK’s ‘unloved and undervalued’ moniker. In response to the valuation conundrum, share buybacks have surged as UK companies adopt this tactic to return value to shareholders and bolster share prices.

Share buybacks are a compelling solution for companies with lots of cash on their balance sheets who don’t want to wait for investors taking a renewed interest in the UK stock markets. Using cash to buy their own shares at low prices could be a good use of the money as it boosts returns for the remaining investors and may also deter international predators keen on securing a bargain for themselves by acquiring UK companies. It does, however, also suggest that these companies are ex-growth and may be lacking in new ideas to invest their money.

Companies announcing recent buyback programmes include Holiday Inn owner IHG, Next, Legal & General and Diageo to name but a few.

The UK has become an attractive target for overseas companies looking to acquire listed businesses, driven by favourable investment opportunities. This surge in merger and acquisition (M&A) interest is largely due to the UK's robust corporate governance, competitive market environment, and relatively lower valuations compared to other markets, as discussed above.

For investors, this trend can be highly beneficial as the influx of foreign capital could stimulate growth and innovation within UK companies, potentially leading to improved financial performance and higher returns for investors.

While the UK market may be smaller compared to the US, it has historically held a high prominence in client portfolios as the UK market was an important stock market and there are still plenty of world leaders listed here.

There remains an appetite for large companies listed on the London Stock Exchange - like Shell and Relx that offer international exposure over domestically focused small and mid-cap companies, as investors want to mitigate the risks associated with the local economic fluctuations.

That’s not to say the UK should be ignored. There are signs of improvement. In the first quarter of 2024, the economy grew by 0.6%⁴ - the fastest growth reported in two years - lifting the country out of recession. In comparison, Germany reported 0.2% growth for the first quarter of 2024⁵. Likewise, the UK stock market performance has improved recently.

As for the UK’s political leadership, the Labour Party is now in government with a comfortable majority. The party wants to raise growth through an economic agenda that includes ensuring stability and investment through its ‘Securonomics’ policy (which is similar to US President Joe Biden’s Bidenomics policy). In short, it’s all about directing business investment to areas where the UK will have a strategic competitive advantage (e.g., green technology).

Labour also wants to reform the UK’s planning system. Shadow Chancellor Rachel Reeves says it’s “the single greatest obstacle to our economic success” because it creates barriers to growth and home ownership.

So, while there’s the potential migration of listings, spurred by the likes of Shell, the increasing prevalence of share buybacks indicates a market in transition, one striving to remain relevant and competitive in an ever-changing world. In the meantime valuations look attractive and if Labour's Securonomics policy proves a success, there’ll be more reason for investors seeking growth in their portfolios to turn to the UK. 

[1] What is behind the FTSE 100 record high and what does it mean?; The Standard, April 2024

[2] AJ Bell; April 2024

[3] AJ Bell; April 2024

[4] Fastest growth in two years lifts UK out of recession; FT.com, May 2024

[5] Gross domestic product in the first quarter of 2024 up 0.2% on previous quarter; Destatis, April 2024