The U.K. stock market is for contrarians only

The stock markets in Europe are much cheaper than the U.S. In fact, based on price-earnings (P/E) ratios, some European indices like the U.K. FTSE 100 are at the cheapest level ever in relation to the U.S. benchmark, the S&P 500.

Is this a buying opportunity, or a value trap?

 

Source: Bloomberg

The U.K. index, the FTSE 100 trades at a 55% discount to the S&P 500 index, as shown in the lower pane, above. Relative dividend yield is shown in the top pane. The value sub-index on U.S. stocks is also trading at a rich premium to the FTSE 100.

This means that even adjusted for the different mix in the FTSE 100 versus the tech-laden S&P 500 the U.K. stocks are much cheaper. The FTSE 100 has more value stocks and fewer tech stocks than its American counterpart. Value stocks trade at cheaper valuations, which is the reason they earn the moniker of “value”.

A typical value stock today would be in energy, and London is the base for global behemoth BP PLC, formerly known as British Petroleum. BP, like other oil companies, trades at a low P/E of 7.5 times. BP pays a dividend of 4.75 percent.

Financials are also considered as value, and the U.K. is home to HSBC Holdings, a global financial company with huge exposure to China. The P/E ratio for HSBC is 10.25, and the dividend yield is 2.33 percent, although the dividend is likely to be increased if regulators allow it. Pharmaceuticals are usually considered value as well.

The top ten holdings for the FTSE 100 ETF, iShares Core FTSE 100 UCITS ETF:

 

Source: iShares

 

The concentration on energy companies is clear, with 11 percent weighting, and pharma, with 10 percent. There is no Apple, Microsoft, Amazon, Google or any other tech behemoth. About 40 percent of the total value is in the top ten.

A closer look at the FTSE reveals that earnings and dividend yield are much superior to the S&P 500 (SPY).

The forward P/E on the FTSE 100 is at only 12, while on the SPY that same measure is at 21.

If we dig a little deeper it becomes clear the valuation gap is more than just an overweight in value.

The market is in love with technology growth stocks that make up the heavyweights in the SPY.

The top holdings in SPY are Apple, Microsoft, Amazon, Alphabet A (Google), Tesla, Alphabet C, NVIDIA, Meta (Facebook), Berkshire Hathaway and JP Morgan Chase. The top five are leading technology companies, and about 8 of the top 10 could be considered in the technology sector.

The discrepancy in valuation is related to the category of company more than geography or value versus growth. One of the few leading tech companies in London, chip designer Arm Limited, is the subject of a takeover bid by NVIDIA and is facing regulatory headwinds.

The reality is that U.S.-based tech companies are leading the world in valuation, revenue, earnings growth and innovation.

A bet on the FTSE 100 is a contrarian bet against the U.S. heavyweight market leaders.

 

Hilliard MacBeth

 

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