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The S&P 500 has more than doubled, but I’d buy the best UK stocks

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The S&P 500 index is now up over 100% since 2016. I think that’s an incredible return, considering the trials and tribulations faced by the global economy over the last five years. It also makes the performance of the FTSE 100 — 5% up over the same period — look derisory. Even so, I still think there are plenty of reasons to keep throwing my money at the best UK stocks.

Why has the S&P 500 outperformed?

That’s an easy one. Even those with only a passing interest in business and stock markets will know that US tech companies such as Apple, Amazon, Alphabet and Microsoft have been on an absolute tear over the last five years. All now have valuations in the trillions of dollars.

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Since these companies have grown so big (and the S&P is weighted according to size), they now make up a much larger proportion of the index. This means those above have a far larger impact on overall performance compared to those lower down. So far, that’s been great news for investors.

The only problem is that the US market now looks extremely expensive, based on its CAPE (cyclically adjusted price-to-earnings) ratio. This calculates a valuation based on earnings per share over a 10-year period. As a result, it helps to smooth out fluctuations in earnings that occur naturally over the business cycle.

Right now, the US’s CAPE is around 38. The only time it’s been higher is before the dot com crash in 2000. By sharp contrast, a CAPE of 15 implies the UK market is still great value. The number of recent takeovers we’ve seen would tend to support this. UK plc is effectively on sale!

A few things to remember…

First, the UK and US markets aren’t the same. We lack tech titans, for example. This doesn’t mean it’s necessarily a waste of time to compare performance. But it does mean we probably shouldn’t base any investment decisions purely on the CAPE.

Second, the quality of UK companies — like in the US — varies greatly. Looking at shareholder returns, the FTSE 100 contains some awful businesses, a lot of average ones, and a few that are brilliant. If I’m going to pick stocks, it’s vital I can identify the latter. For this, I tend to use the same strategies favoured by top UK fund managers, such as Terry Smith and Nick Train.

A follow-on point is that the best UK shares rarely come with a bargain price tag. So when I mention buying the best UK stocks today, I’m talking about striking a balance between value and quality. In practice, this might mean buying an expensive-looking stock if I’m confident it could still deliver a great return over the long term. It also might mean avoiding something even though it appears ‘cheap’ at face value.

I’d buy British

If this sounds like I’m bearish on Uncle Sam, let me be clear. I won’t be ditching my holdings in quality US stocks (or funds holding them) because the S&P 500 is due a correction or crash. Experience has taught me that trying to time the market is something I can’t do. However, I do think there’s a potential for better gains from our home market as post-Brexit, post-Covid-19 sentiment improves.

There remain risks, of course, but I still think now’s the time for me to buy British.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Paul Summers has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Alphabet (A shares), Alphabet (C shares), Amazon, Apple, Microsoft, Netflix, and Zoom Video Communications. The Motley Fool UK has recommended the following options: long January 2022 $1,920 calls on Amazon, long March 2023 $120 calls on Apple, short January 2022 $1,940 calls on Amazon, and short March 2023 $130 calls on Apple. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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