UK shares, despite pushing forward during the week, are trading at historic lows. Over five years, the FTSE 350 is down 2.74%, representing negative annual growth of around 0.5%. So why would I invest in this market when many investors are skeptical?
Extreme pessimism
Analysis have started talking about the impact of extreme pessimism surrounding UK stocks. As noted, the largest 350 companies listed in the UK are collectively valued at less today than they were five years ago.
So why is this? Well, we can start with a war in Europe, and coupled with the threat of escalation, its impact on economic growth. We can also note the UK’s exit from the EU as a factor that has introduced a level of uncertainty for businesses and investors. Investors don’t like uncertainty.
Moreover, we can observe broader global economic issues including high levels of inflation and rising interest rates. Collectively, these factors have negatively influenced investor sentiment.
However, company earnings have remained strong throughout this challenging period. This resilience, coupled with falling share prices, has contributed to some very attractive valuations. UK stocks across the board trade at a discount versus their US peers. Even surging BAE trades at a 10% discount versus US defence peers.
Don’t follow the crowd
Legendary investor Warren Buffett advises against following the crowd. He famously said: “Be fearful when others are greedy and greedy when others are fearful.” The so-called Oracle of Omaha encourages investors to think independently and make decisions based on their own analysis and judgment rather than blindly following popular opinion.
And that’s great, because investing in depressed markets which aren’t favoured by investors, especially international investors at this moment, provides us with the opportunity to scoop up cheap UK stocks with elevated dividend yields.
This is important for those of us investing for passive income. When share prices fall, dividend yields tend to increase. The relationship is inverse. The dividend yield is calculated by dividing the annual dividend per share by the share price. As the share price declines, while the dividend remains the same, the dividend yield rises proportionally.
This is why there are around 60 companies on the FTSE 350 offering dividend yields in excess of 6%. Previously, this was almost unheard of. Locking in these high yields now provides Britons with the opportunity to supercharge their portfolios going forward because the yield at the time of purchase is always reflective of the yield I will receive.
More than passive income
UK stocks also offer the promise of share price growth. The average price-to-earnings on the FTSE 100 is around 14, which is considerably below the S&P 500 at 21. Yes, it’s a different type of index, but the figures are illustrative of the discount UK stocks are trading at.
The only issue is when will UK stocks break out of their slumber and push up? For now, investors can snap up great dividend yields, but long-term index growth will likely depend on an improving macroeconomic environment and a more certain post-Brexit future.
