The UK stockmarket is cheap. The cyclically adjusted price/earnings ratio (Cape), which uses average annual earnings over the past ten years to smooth out the impact of the economic cycle, is very close to the level it reached in 2009 after the financial crisis. Historically, a Cape this low has flagged up double-digit annual returns over the next 15 years. Of course, the market could go lower before it goes higher, but in general we believe it is a market to buy for the long term.
The US, by similar valuation measures, is expensive and offers much smaller prospective returns. There is a reason for this: the US has much greater exposure to long-term, or structural, growth stocks such as Facebook, Amazon, Netflix and Google. The UK has very few large structural winners and those that have done well in recent years, such as Spirax Sarco, Halma and Games Workshop, change hands for around 40 times this year’s expected profits.
Mixing growth and value
Growth stocks have outperformed now for ten of the last 12 years and many of them are now looking unjustifiably expensive. We think investors do not have to make a choice between expensive growth and pedestrian value. Our predominantly mid- and small-cap approach seeks to buy out-of-favour long-term winners and smaller companies that often grow faster and have much cheaper valuations.
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One to consider is Whitbread (LSE: WTB). The Premier Inn budget-hotel group had a great recession in 2009, taking market share from weak competition. The same looks likely to happen this time. Budget hotels are the one sector of the hotel market that have seen long-term growth. Of course, hotels have recently been in lockdown and will take some time to return to a “new-normal” level of demand, but this is hurting competition such as Travelodge and independent operators. Whitbread has a very strong balance sheet with lots of freehold property and cash, and looks well placed to emerge from the downturn stronger. The shares have halved from recent highs and should recover nicely for patient investors.
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