Low interest rates and the range of industries offer scope to generate significant returns from the British stockmarket, despite the widespread fanfare about growth in emerging markets.
With interest rates anchored at all-time lows and government bond yields at unattractive levels, income-seeking investors are turning increasingly to equities, and this may lend support to higher-yielding companies. The British market offers a 2011 prospective dividend yield of 3.4% – a competitive figure compared with gilts or equivalent corporate bonds. What is more, Britain is expected to deliver dividend growth of 11% in 2011 – higher than any other major market.
In addition, valuations remain cheap relative to history and to other assets. The dividend yield discussed above is only one of a range of measures that reveals compelling value. For example, on a 2011 price/earnings (P/E) basis, Britain is cheaper than any of the other major equity markets, despite offering earnings growth that is at least the equal of its peers and underpinned by operational gearing following cost cutting undertaken during the recession. The market also trades at a substantial discount to its long-term average P/E ratio over the past 20 years. Similarly, the market is well below long-term averages on a price-to-cashflow and price-to-book basis.
Corporate activity has been a feature of the British market this year, with the takeovers of Chloride, Dana Petroleum and SSL. Several factors suggest that this theme has further to run. For example, companies are generating high levels of free cash that is earning meagre returns on the balance sheet. Funds can readily be topped up by issuing corporate bonds at historically low rates of interest.
Valuations, as discussed above, are cheap and this makes M&A a relatively attractive way of supplementing a company’s organic growth. Meanwhile, investors are pushing for cash to be deployed in shareholder-friendly ways. Taking these factors together, companies will continue to take advantage of the value that is evident in the market by making earnings-enhancing acquisitions.