There has been a pervasive misconception about UK companies when compared to those in the US that they don't have as much to offer in terms of exciting opportunities and, for market participants, returns.
Comparing the valuation and dividend trends – two of the most crucial factors for investing – on UK and US stocks the former trumps the US.
The ability to buy shares in companies at inexpensive prices and receive generous dividends makes the UK an appealing place to invest money.
Historically, there has been a home bias for UK individuals who did invest, and while that’s still the case it began to fade 10 to 15 years ago as more people seized on tech-related opportunities in the US. Such portfolio positioning worked for a long time, but there’s now good reason investors are reappraising their US exposure and looking back at the UK.
Concerns are growing about excessive valuations in the US and what could happen if there is an AI-related bubble and it pops. Equally, there is a backlash against policy decisions from the Trump administration which has led certain investors to reduce exposure to the US. Both of those factors have worked in the UK’s favour from an investment perspective, and the performance data also looks compelling.
More than one third (34%) of the current members of the FTSE 100 have generated better returns for investors than the S&P 500 index of US companies over the past five years. The UK has been unloved and underappreciated for years, and investors can use that status to their advantage. There is much on offer, and you do not have to pay over the odds for it.
Chancellor Rachel Reeves wants to get Britain investing again, to put more money into people’s pockets and drive economic growth. If she succeeds, it would be great for consumers, businesses, and the whole country.
UK versus US valuation comparison
The FTSE 100, the UK’s flagship equity index, trades on 13.1 times the next 12 months’ forecast earnings. That is a 37% discount to the S&P 500’s 20.8-times rating and illustrates the wide valuation difference between the UK and US.
The UK discount is currently higher than the average valuation gap over the past 10 years (33%). Investors got over-excited about tech and AI, putting big American firms on rich ratings, whereas UK stocks just trundled along as normal. The US market is now trading well above its 10-year average of 19 times forward earnings whereas the UK is only marginally ahead.
The gap between the US and the UK has not always been this big. In the prior 10 years (to 20 April 2016), the US traded on an average 13.9 times forward earnings versus 11.7 from the UK. Put another way, in that 10-year period the US premium was only 16%, which is less than half the current level.
There are reasons why the UK now trades on a much lower rating than the US. These include slower earnings growth, more exposure to cyclical sectors, fewer options in the tech space, and less willingness among investors to pay a high price.
While that makes the UK sound sluggish, there are reasons to be positive. Buying cheap gives you an advantage longer term, and that is where the UK market shines.
You can buy shares in the best company in the world but pay too much and you are dependent on everything going perfectly forever. The slight bit of unwelcome news can destroy highly rated shares. Over time, one would expect mean reversion, where prices, valuations and returns move back toward long-term averages.
In contrast, a low starting valuation gives you a margin of safety, namely room to deal with bumps in the road. If a ‘cheap’ company proves its worth, the investor benefits not only from rising earnings but also an increase in the share valuation towards a more reasonable rating.
Dividends in the UK versus the US
There are two ways to make money with investing. One is to sell your investments for more than what you paid, known as a capital gain. The other is to earn an income through dividends or bond interest payments.
Investors highly prize income, particularly those in retirement lamenting the loss of their monthly pay packet and looking for a replacement way to pay the bills.
The UK stock market is an attractive hunting ground for income. It currently offers a 3.2% yield, based on the expected dividend payments on the FTSE 100 index over the next 12 months. That is more generous than the 2.1% prospective yield on the S&P 500.
US corporates typically prefer to reinvest surplus cash back into their business or use the money for share buybacks. In the UK, there is a long-standing dividend culture where companies on the market are often more mature and understand the value of regular cash rewards for shareholders.
Reinvesting dividends can turbocharge your returns thanks to the power of compounding. Do not underestimate the ‘old economy’ names on the UK market – banks, insurers, engineers, and industrial suppliers can be the secret sauce to help investors ‘get rich slowly’.
Despite a clear bull case for the UK, it is not as simple as choosing one market over the other. Instead, investors might want to consider having exposure to both regions as part of a diversified portfolio, rather than believing just the UK or the US is the only way to go.
Dan Coatsworth: Head of Markets
Dan Coatsworth is AJ Bell's Head of Markets. Dan has been with the company since December 2012 and has more than 18 years' experience in the industry, following the markets and all things investing. He...
