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Shares Magazine
As Fundsmith founder Terry Smith is fond of reminding investors, in the long run earnings drive share prices rather than the other way around.
Investing in stocks successfully is often about subtly shifting the odds in your favour. This can mean owning stocks which have lower valuation risk, or in other words aren’t being overvalued by the market, while still offering the prospect for good earnings growth.
The impact of valuation on share price performance is not always immediate but typically it does eventually influence investment returns through the PE (piece to earnings) ratio, as well as other valuation metrics.
Ebbs and flows in the PE mirror rising and falling investor sentiment, which enhance investment returns during up cycles and detract during down cycles.
As a reminder, total investment return can be broken down into three parts: growth in earnings per share, dividend yield, and the change in valuation.
Current forward PE valuations are close to multi-year highs
UK valuations are sitting close to their highest levels in five years, based on forward PE (price to earnings) ratios. This is based on consensus analyst earnings expectations of UK companies in the FTSE 100 over the next year.
Other major markets are also trading at historically high valuations with the US probably the most ‘stretched’ based on long-term averages.
It is important to remember that while there isn’t a crystal ball telling investors when PE ratios have gone too far, they can move back down without any warning.
Where have share prices lagged earnings?
One way of thinking about where the value might be is to look at how share prices have performed against earnings.
We have crunched the numbers on the UK’s largest companies to find those where share price growth has lagged earnings growth over the last five years.
To make sure we were not simply identifying ‘value traps’ where earnings are falling because of an established structural trend, we narrowed the search to companies which have grown earnings at least 10% a year on average over the last five years.
To reduce the risk of identifying companies which may be undergoing a de-rating (falling PE) from a high level, we eliminated companies with a forward PE above the five-year historical growth rate.
The companies in the table have grown earnings at a compound annual rate of at least 10% a year and trade at a discount to their five-year growth rate.
Back to the future
Global sports retailer JD Sports Fashion has seen its PE sink into single digits from more than 20 times before the pandemic. This puts the company in the deep-value category suggesting investors anticipate low growth.
This belies the company’s ambitious five-year plan to become a global sports fashion ‘powerhouse’ targeting 1,700 to 2,000 net new stores by 2029.
Signalling their confidence, management completed a £200 million share buyback in early 2026 and analysts believe the company is on track to generate £400 million in free cash flow, representing a double-digit free cash flow yield at the current share price.
After a reset year, JD Sports is expected to return to growth with pre-tax profit increasing by mid-single digits with consensus forecast earnings of between £880 million and £910 million. However, a difficult consumer backdrop could be an obstacle to achieving these numbers.
Emerging growth potential
Wound management specialist Convatec has evolved from a long-running restructuring story into a company with sustainable revenue growth and margin expansion.
Management has consistently upgraded organic revenue growth to a range of 6% to 8% and is targeting a medium term adjusted operating margin of 24% to 26%, up from 23% in 2025.
This is expected to be achieved by a combination of operating leverage and continued streamlining of the firm’s manufacturing footprint.
Around 80% of Convatec’s revenues are generated by selling consumables like wound dressings and insulin infusion sets used to treat chronic conditions.
Increased outsourcing in global food services
Catering group Compass is seeing a structural shift in the global $400 billion food services market, buoyed by increasing regulation and rising food costs are pushing more inhouse operators to outsource.
Nearly half of new business wins in the last financial year came from first-time outsourcers, while client retention remained high at over 96%. With around 70% of profits coming from the US, Compass recently changed its trading currency to US dollars.
The company is guiding for 10% underlying operating profit growth in 2026 driven by operating margins moving back towards pre-pandemic levels of at least 7%, helped by pricing discipline.
Martin Gamble: Shares and Markets Writer
Martin Gamble is Shares and Markets writer at AJ Bell. He was previously the Education Editor of Shares Magazine. He has been with the business since 2019.
Martin graduated from the University of Kent in...
