Some of the best valuation opportunities lie among UK domestic-focused stocks. Your challenge is to shift through the pack and find ones which stand a chance of re-rating in a market where sentiment remains poor towards companies doing business in the UK.

Weighing on sentiment is renewed political concern which this week dragged down the value of sterling once again. That in turn has weighed on the FTSE 250 index which contains a large number of UK domestic stocks.

The currency has weakened amid growing concerns about the future of Theresa May as prime minister. Last weekend, reports suggested that 40 Tory MPs had agreed to sign a letter of no confidence in May.

And on Monday business leaders told the prime minister that she needed to speed up Brexit talks with the European Union.

Talking at AJ Bell’s Investival conference last week, Invesco Perpetual’s Mark Barnett said the market believes Brexit is ‘an accident waiting to happen’. That’s why many UK domestic-focused stocks have been marked down in valuation terms – amid fears about what Brexit could do to the UK economy.

What's happening with earnings?

‘The market is pricing in quite a pessimistic outcome. Investors said at the point of the referendum vote that the UK economy would go down fast. That still stands today; people are saying avoid domestic stocks,’ he commented.

‘However, earnings from domestic companies remained positive apart from a period after the referendum when analysts downgraded forecasts. They’ve been upgraded since, so overall the earnings picture remains relatively stable.’

Against that backdrop, stocks which have suffered downgrades to earnings due to sales disappointments have also seen a downgrade to their stock rating – essentially they are trading on lower earnings multiples. Good examples are outsourcing group Capita (CPI) and retailer Next (NXT), said Barnett.

On the flip side, investors are happy to pay high prices for stocks that have already done well. Barnett is convinced this trend will change. He believes there are three reasons why this might happen.

US monetary tightening might start to affect some ratings versus the rest of the market. A resolution around some of the Brexit uncertainty might get overseas investors to look at the UK again. Or valuations could get too stretched as people have paid high multiples for companies where the rating isn’t justified. Over time you would expect the market to reprice those stocks back towards fair valuations.

So if you’re brave, now might be a good time to start looking at the multitude of UK-focused stocks on depressed valuations.

Real estate bargains

One of Barnett’s top picks among sectors with depressed valuations is UK real estate where the market has taken a gloomy view of near-term prospects. He highlights office specialist Derwent London (DLN).

‘There are companies in the sector trading at a 25% discount to book value and selling assets at book value or at a premium. Or they are selling assets at a premium and retiring equity at a 25% discount,’ commented the fund manager.

‘There is significant overseas interest in this sector. I imagine we’ll see some deals.’ (DC)

‹ Previous2017-11-16Next ›