Interactive Investor

Cheap UK shares and a warning for income seekers

These experts offer advice on playing the stock market in 2020 and three tips for dividend investors.

18th December 2019 14:35

Graeme Evans from interactive investor

These experts offer advice on playing the stock market in 2020 and three tips for dividend investors.

As investors ponder their strategies for 2020, fund managers at Schroders have highlighted a potential revival for value stocks in a UK market currently distorted by extremes.

They also have a word of warning for income seekers, who they say may need to adjust their expectations, be prepared to invest for longer and diversify investments more.

The 2020 look ahead by Schroders comes with the UK equities trading at a 30% valuation discount to global peers, which is close to a 30-year low.

While domestically focused stocks are out of favour, Schroders notes that some areas of the market are still very expensive with investors paying large — some would say unsustainable — premiums for the safety of quality growth stocks.

Such companies combine faster-than-average revenues with consistent profitability, market-leading positions and low debt. Schroders doesn't name names, but examples might include Berkeley Group (LSE:BKG) in the FTSE 100 index or Howden Joinery (LSE:HWDN) in the FTSE 250 index.

With growth an increasingly sought-after commodity, the price-to-earnings metric shows such stocks being valued almost twice as highly as value counterparts. However, Schroders points out that these distortions will not last forever. 

They said: “If monetary policy has indeed been stretched to its limits, then fiscal policy and economic restructuring will likely be turned to in order to lift economic activity.

“Financial markets may see this as a trigger for rising inflation and higher interest rates. This would likely be supportive to the outperformance of lowly-valued value stocks over their growth counterparts.”

Schroders added that a Brexit resolution should be positive for UK value stocks, such as domestic banks, property companies, housebuilders, general retailers and leisure companies, food retailers, media agencies and utilities.

They said:

“Accordingly, we have a slight bias towards more lowly-valued stocks at the moment, where we can still find equities that are not priced for perfection.”

The report also notes that UK domestic quoted stocks still have appeal for foreign investors, with pub operator Greene King (LSE:GNK) among those on the receiving end of M&A activity.

Other examples include Dairy Crest (LSE:DCG) (snapped up by a Canadian peer), Telford Homes (LSE:TEF) (bought by American real estate firm CBRE) and Hull broadband provider KCOM Group (LSE:KCOM), acquired by Australian investment business Macquarie.

Schroders added: “October’s Brexit bounce gave a taste of what might happen should sentiment improve — the share price recoveries of investment trusts invested in UK small and mid-cap companies were particularly pronounced.

“Such trusts tend to have a greater exposure to UK domestically focussed shares than their large cap equivalents do.”

The advice for income seekers, meanwhile, is that a dose of realism may be required. Schroders noted a recent investor survey in which it found average expectations for annual investment returns over the next five years stood at 10.7%. Even higher risk, and potentially higher return, asset classes like shares don’t offer these kinds of returns.

Rupert Rucker, Head of Income Solutions, said:

“Investors and savers around the globe seem to be drawing on their memory of the 1970s, 1980s and 1990s, when interest rates looked very different to now.”

Looking to 2020, he said the dividend yield on most equity markets remained attractive, with levels highest in Europe and Asia at close to 4% and much higher than the 2% seen in the US.

Rucker offers three tips for those seeking sustainable, higher income in 2020 and beyond.

He said: “Firstly, educate yourself about the market. Higher returns are available but they are likely to carry higher levels of risk.

“A second, related point, is that investing for a short time period is unlikely to bring the best returns. A time frame of at least five years is likely to be needed, particularly when investing in higher risk assets such as shares.

“And thirdly, it’s important to start as soon as possible. This allows your investment to grow through the power of compounding.”

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.