Don’t Buy The FTSE 100 To Benefit From Britain’s Boom

Happy days! Barely a week goes by without more good news about the UK economy.

In just the past few days, we’ve learned that UK industrial output is rising at its fast annual pace since 2011;

We’ve had Halifax reporting the strongest monthly rise in its house price index since 2002;

And we’ve seen the International Monetary Fund backpedal to admit it had previously underestimated the strength of the UK’s recovery, as well as stating our recharged economic vigour could persist for years to come.

We’ve even learned that the ONS is set to bump up its estimate of UK economic output by tens of billions of pounds overnight — although in this case it’s because the rules are being changed to allow everything from weapons spending and illegal drugs to prostitution to count in the official measure of GDP…

Okay, so Chancellor George Osborne may want to tread carefully before he brags about that being a sign that his economic plan is on track.

But the bottom line is the UK economy is surging. And after so many years in the doldrums, it’s only natural to wonder if you should now profit by investing in the UK’s leading FTSE 100 (FTSEINDICES: ^FTSE) shares?

You snooze, you lose

My answer: not so fast!

For starters it’s important to remember that the stock market is typically a discounting machine. Investors know that higher profits will likely boost share prices so, rather than looking in the rear-view mirror, they concentrate on trying to anticipate how companies will be perform in future.

Sure enough, UK shares were climbing for years before the green shoots of our economy revealed themselves to be genuine signs of growth, as opposed to festering weeds. UK housebuilders like Barratt Developments and Taylor Wimpey saw their share prices surge five-fold or more from their lows in 2011, for example. That’s far in advance of any real confidence returning to the housing market, and well ahead of recent record price growth.

It’s a similar story in other sensitive economic-related sectors such as banking — think Lloyds in particular — although not all sectors have benefited.

The share prices of UK supermarkets for instance have been steadily sliding in the other direction, despite the economic good news. Most onlookers would agree that this is the result of particular difficulties in that industry, however, as opposed to say a reflection of optimism (or lack of it) among UK consumers.

Not made here’ syndrome

So that’s one reason to be cautious before loading up on the FTSE 100 to ride with the UK boom — you might be too late!

But there’s another even more fundamental reason to be wary, and that’s to do with the nature of our largest companies and where they make their money.

You see the majority of the sales and earnings racked up by Britain’s biggest firms are generated overseas. Estimates vary, but it’s commonly reckoned that at least 70% of earnings from companies listed on the London Stock Exchange are generated abroad.

As such, an investment in the FTSE 100 is more a bet on global economic growth than a good way to play the UK economic recovery.

Bigger than Britain

This isn’t so surprising when you think about our largest companies.

Even after the sale of its US Verizon Wireless division, Vodafone is one of the world’s largest mobile phone operators, with customers stretching from here to India and beyond.

HSBC does much more business in Hong Kong than in Britain.

And Royal Dutch Shell and BP would be a shadow of their massive selves if they only extracted, refined, and sold oil in the UK.

In reality of course, their operations, like those of nearly all our biggest firms, span the globe.

How to invest in UK plc

Does this mean that the UK stock market has nothing to offer those who want to bet on the UK economy?

Absolutely not! There are plenty of stock market listed UK firms that stand to benefit from superior economic growth in Britain, but you do have to choose wisely.

I’ve already mentioned how the housebuilders and Lloyds have prospered, for instance. The key is to understand where and how any potential investment makes its money.

As a general rule, you’ll find a greater number of more direct plays on the UK recovery as you move down the size spectrum, for the obvious reason that to get very big, mega-companies typically had to long ago step outside of our borders to keep growing.

The mid-cap index especially has proven rich pickings over the years, but be sure to do your research.

You might also want to take a view on those struggling UK supermarkets I cited, and in particular Tesco. At one point Tesco took £1 of every £7 that was spent in UK tills, and while it sells groceries in cities across Europe and Asia, the UK remains by far its most important market. Its fortunes are clearly weighted to the economy as a whole.

Download our special free report on Tesco to learn more about how its managers plan to retain and enhance Tesco’s prime position in the UK retail landscape.

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Both Owain and The Motley Fool own shares in Tesco