As we all know, the risks of a hard Brexit are extremely high. But it doesn’t mean that investors should avoid Footsie shares. Instead, they should add purely domestic stocks to their portfolios.
Brexit uncertainty
It looks like the UK’s government has taken a hard stance towards negotiations with the EU. There are certain points that the UK and the EU simply cannot agree on. For example, they cannot reach a compromise on fishing rights. It seems that the negotiations might go on for a long time. But the most serious problem is the December deadline, I think. The British government and Parliament simply do not want to extend it. So, I think the chances of a hard Brexit are quite high. But don’t worry! You can hedge against this risk by buying some purely domestic companies’ shares. What do I mean by this? Well, these companies rely on the UK’s consumers and not the EU’s markets.
Purely British stocks
As my colleague Jonathan Smith pointed out, purely domestic shares should be bought as a hedge against a hard Brexit. I agree with him. Some of the stocks Jonathan mentioned seem to be less risky than others.
Taylor Wimpey is a housebuilding firm. Since it has little to do with the EU, it could look like it is less of a risk than many Footsie companies. However, there is a rather indirect link between the company and the Brexit. Many economists argue that a hard Brexit would lead to a long-lasting recession. If they are right, then a recession would lead to a dramatic fall in people’s incomes and savings. As a result, they would have much less cash available to spend on houses and flats. So, the demand for Taylor Wimpey’s services would decline, leading to a significant reduction in the firm’s revenue and profits.
In my view, supermarkets are by far a much better alternative to housebuilders if a hard Brexit takes place. This is because supermarkets sell groceries and other essentials. Obviously, consumers have to eat and buy hygiene items regardless of their incomes. Moreover, this type of goods also takes a relatively small proportion of people’s incomes. So, they will not significantly reduce their spending on the goods sold by largest UK supermarkets. Finally, supermarkets like Tesco and J Sainsbury are not overexposed to the EU’s markets either. All this makes this sector a rather risk-free bet in case of a hard Brexit. But the question is whether to choose Tesco’s or J Sainsbury’s shares.
I think that Tesco is a better alternative to Sainsbury. First of all, the former is much larger. Sainsbury’s sales revenue in 2019 was a little bit above £28bn as opposed to Tesco’s sales of over £63bn. Moreover, Tesco’s net profit margin, a key efficiency indicator, is 1.5% compared to Sainsbury’s net profit margin of 0.5%. Then, Sainsbury’s price-to-earnings-before special-items ratio is 33 as opposed to Tesco’s 23. This means that Sainsbury is more overvalued than Tesco.
So, my choice among these British shares is definitely Tesco. However, I don’t think that an investor should only focus on “purely British” shares. There are many other FTSE 100 companies that can surely survive and flourish even during a tough recession.
