This article was taken from the September 2024 issue of Market Insight. To subscribe to our investment publications, please visit www.redmayne.co.uk/publications.
The origins of the London Stock Exchange can be traced back to Jonathan’s Coffee House in the heart of the City in 1698. John Castaing began publishing a list of stock and commodity prices for the benefit of the traders gathering there after their expulsion from the Royal Exchange for rowdy behaviour. Over the following centuries, rules and systems were formalised, traders found some decorum and the scope of the exchange grew ever wider.
Today, the London Stock Exchange is headquartered close to St Paul’s Cathedral, only a short distance from the site of its founding. The main market contains over 1,000 issuers and has a market capitalisation of £4.4tn. The UK equity market is of global importance and almost everyone in the UK will have a stake somehow, whether directly or through a workplace pension.
Recent years have seen a pessimistic narrative emerge for UK equities, however, and their importance on the world stage has diminished. UK equities now represent only 3% of global market capitalisation, down from 5% in 2019. Pension funds have slashed their UK equity allocation and UK-focused equity funds have seen net outflows for some time. The small and mid-cap space in particular has suffered, with a falling number of companies decreasing the overall market cap and liquidity. This in turn means limited funds for initial public offerings (IPOs) and capital raises which will inhibit the growth of smaller UK companies. Growing concerns have led to calls for a ‘UK ISA’ with a separate allowance for investment in UK companies in a bid to revive a lacklustre market. Similar schemes have been proposed by politicians, think tanks and columnists.
Despite this seemingly gloomy outlook there is still a strong investment case to be made for the UK equity market. Fundamentally, the UK can be a good place to invest, benefitting from the rule of law, a well-established financial services sector and London as a global financial centre with access to capital from around the world. The UK market contains many quality, market-leading companies. Valuations are cheap, acquisitions are frequent and income-seeking investors can find reliably growing dividends. Specialist sectors where the UK excels, such as bioscience and TV and film production, may also present potential opportunities. Let’s examine some of the companies defying the prevailing narrative and powering UK growth.
Rolls Royce plc has become a household byword for luxury, but its eponymous cars are only a small part of this FTSE 100 constituent’s business. The company manufactures engines for aircraft, ships, submarines and other specialist engineering projects. 2020 saw something of a low point for the company. Heavy annual losses caused the dividend to be suspended and the company was compelled to launch an emergency rights issue in order to raise £2bn, with the UK Government acting as guarantor. Four years later, however, the company has performed an impressive turnaround. 2023 saw record cashflow and a 60% increase in underlying profits. The share price has reacted accordingly, growing by over 100% in the last 12 months alone. When the company announced in August 2024 that dividends would be resumed, the price reached an all-time high of 501p. In the same month, the company also announced a deal with Cathay Pacific airlines to manufacture 60 Trent 7000 engines for its fleet, along with a maintenance package. Looking to the future, as a market leader in small modular reactors (SMRs), this currently unproven technology could present a growth opportunity if the UK Government does decide to commission any.
There may also be value to be found in UK real estate. Many will be familiar with the buy-to-let model popular with individual landlords, but there are other avenues to income through property. For example, Primary Health Properties is a real estate investment trust (REIT) and a FTSE 250 constituent which invests in long-lease healthcare properties in the UK and Ireland, such as GP surgeries where the rental income comes from the Government or Government-backed bodies. The portfolio contains 514 healthcare properties, valued at a total of £2.8bn. The long investment horizon, a high occupancy rate and secured income have led to 27 consecutive years of dividend growth, with a yield currently standing at around 5.8%. There are, though, concerns that many current GP surgeries require significant modernisation, as referenced in a June 2024 report by the Institute for Government.
While financial news is often dominated by stories of American tech giants and artificial intelligence (AI) speculation, UK investors should not overlook those profitable home-grown companies with a proven track record. For example, Halma plc has been a publicly listed company for 50 years and currently holds a place on the FTSE 100. It consists of a group of companies specialising in safety equipment and infrastructure, healthcare and environmental analysis. Collectively, these companies have operations in more than 20 countries worldwide. In its full year results for 2024, Halma announced 10% growth on revenue and profit and its dividend increased by 7% to 21.61p. Dividend growth has historically been strong, with 45 consecutive years of dividend growth of 5% or higher. The company aims to continue growth via acquisitions of quality businesses and deliver value for shareholders by doubling earnings every five years. However, in its 2024 annual report, the firm noted that its residual risk level relating to economic and geopolitical uncertainty had increased, despite having limited direct exposure to geographies with high geopolitical risk.
There are also some positive tailwinds for the UK market. Inflation has returned to a more manageable level. From a peak of 11% in the autumn of 2022, inflation has fallen back to 2.2%, tolerably close to the Bank of England’s 2% target. After 13 consecutive base rate increases, the Bank’s Monetary Policy Committee announced the first cut of 0.25% in August 2024. If inflation continues on a downward trajectory, further rate cuts may be expected. A new landscape of falling rates and the yields available on cash and fixed interest stocks could see a resurgence of enthusiasm for the UK equity market. After slowing down towards the end of last year, the UK’s growth trajectory looks more promising. This summer, the International Monetary Fund (IMF) upgraded its UK growth forecast from 0.5% to 0.7%. Overseas investors have been taking an interest in UK companies, with 2024 seeing the highest value of bids for UK companies since 2018. This is significant, as it suggests these overseas bidders see a buying opportunity in this overlooked sector. However, it can’t be forgotten that the UK saw two successive months of zero growth between June and July 2024, with the new Government naming the growth of the economy as one of its priorities.
While it’s certainly the case that the UK doesn’t have an equivalent to the fast-growing NASDAQ titans of Apple or Nvidia, the FTSE 100 is not necessarily the old-world index it has been typecast as. Banks, miners and oil and gas companies remain, but the index has a much more diverse and global scope than might be assumed - around 77% of the index’s aggregated earnings come from overseas. Profitable and well-run companies are in the business of everything from precision engineering to leasing GP surgeries. If investors do their research, they may find a wealth of opportunities.
Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance. The information and views were correct at time of writing but may have changed at point of reading.