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The London stock market is not what it was. Listings are scarce. Successful listings are scarcer. Chest-beating pundits blame the depressed post-Brexit economy, red tape and yield-hungry fund managers. These factors have supposedly lumbered London with a large structural valuation discount.
That thesis now has a challenger in the form of James Arnold, a banker at UBS. Analysis by his strategic insights team suggests City declinism has been inspired by comparing British apples with American pears.
It is undeniable that the UK market broadly trades at a depressed price-to-earnings ratio. Before the 2016 Brexit referendum, it traded in line with the global average at about 15 times forward earnings. If you stripped the US out of the comparison, there was even a small premium.
Since 2016, the standing of the UK has progressively deteriorated. The discount hit a record level of 40 per cent against world stocks at the end of last year. The gap was 20 per cent against the world ex-US. The UK now trades on just 10 times forward earnings.
Arnold’s quibble is that these comparisons are not like-for-like. His team paired 60 big UK blue-chips with US peers they judged to be closest in type. Pairs included caterers Compass and Aramark, and engineers Renishaw and Nvent.
UBS found that the British stocks were either in line with US peers or higher in two-fifths of the cases. A big chunk of discount evaporated simply through the exclusion of a handful of US tech giants, such as Meta and Amazon. These have no real peers in the UK, or anywhere else.
The remaining difference points to a slim UK structural discount. This reflects higher US returns on capital, a function in turn of lower taxes and a bigger domestic market.
A cynic might say you can support any thesis you like with handpicked data. Even so, UBS deserves credit for challenging accepted wisdom. The latter often turns out to be wrong
Arnold believes an inflection point is near. Only a slim sliver of UK defined benefit pension money is still invested in UK stocks. Defined contributions and other alternative retirement savings should now start mounting up. That should support broad market valuations, as well as the kind derived from like-for-like comparisons.
The Lex team is interested in hearing more from readers. Do you buy the thesis that most of the UK stock market’s discount disappears in a like-for-like comparison? Please tell us what you think in the comments section below.
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