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As of April 5, just two LSE-listed shares under coverage can boast ratings of 5 Stars, suggesting they are undervalued, while another four companies look mildly undervalued with 4 Star ratings.
Read How to Invest When the Market is Fairly Valued for guidance on how to cope with the current environment.
Morningstar’s equity analysts go to great lengths to estimate a fair valuation for each stock under coverage, utilising our extensive free cash flow valuation model. This fair value estimate is then compared against the current market price of the shares on a daily basis to calculate a rating for each. The Morningstar Rating for Stocks is a sliding scale from 1 Star (overvalued) to 5 Stars (undervalued) with 3 Stars implying that the shares are fairly valued by the market at present.
5-Star UK Shares
BHP Billiton (BLT)
Following 30 years of decline, the world is again experiencing a sustained increase in commodity prices. The last long-cycle uptrend, born at the end of the Great Depression, was driven by the rebuilding of Europe after the wars and later on the rise of Japan to economic powerhouse status. The oil shocks of the 1970s were an effective death knell. The current rise, forged on the industrialisation and urbanisation of the world's most populous country, began early in the final decade of the 20th century, though the seeds were probably sown considerably earlier.
China's rise from economic obscurity has sustained commodity price growth into the 21st century. Despite now accounting for the lion's share of global consumption of many commodity staples, its per capita use remains well below that of industrialised nations--the difference being China's vast population. India's near-equivalent numbers portend a lagged reinvigoration of commodity price support. The milestone decade of growth need not spell the end of the current boom.
Positioned in the centre of this enviable tailwind, BHP is the world's largest publicly traded mining conglomerate, with the wherewithal to weather the boom-and-bust cycles of the volatile commodity markets. Geographic and product diversification give BHP more stable cash flows and lower operating risk than most of its mining peers. Most revenue comes from the relative safe havens of Australia/New Zealand, North America and Europe.
Rio Tinto (RIO)
Rio Tinto is a top-tier global miner along with BHP Billiton, Brazil's Vale (VALE), and UK-based Anglo American (AAL). A world-class asset base and capable management make Rio Tinto one of the few miners to earn more than its cost of capital through the commodity cycle. Geographic and product diversification give the company relatively stable cash flows and lower operating risk than many of its mining peers. Most revenue comes from the relative safe havens of Australia, North America and Europe, though operations half a dozen continents.
4-Star UK Shares
BG Group (BG.)
BG Group's early entry into liquefied natural gas made the firm a leading global integrated natural gas player, positioning it to capitalise on growing global demand for natural gas. The next decade will see BG expand its LNG activities by developing its extensive gas resource in Australia. Meanwhile, a pre-eminent position in offshore Brazil should lead to high-quality oil production growth.
ICAP (IAP)
ICAP is one of the largest interdealer brokers in the world. Interdealer brokers primarily facilitate over-the-counter transactions in foreign exchange, fixed income, commodities and derivatives between financial institutions via electronic trading systems or interaction with a voice broker. The majority of transactions are done on an agency or matched-principal basis, so there's materially less risk on an interdealer broker's balance sheet than an investment bank's. Financial regulatory reform has both opened up opportunities for and poses threats to interdealer brokers, but we believe that ICAP is arguably one of the best positioned among peers to thrive after reform implementation.
Royal Bank of Scotland (RBS)
Royal Bank of Scotland, formerly a dominant UK bank, was undone by its global ambitions, in our opinion. RBS destroyed its narrow economic moat with its reckless acquisition of ABN AMRO at the peak of the market bubble in 2007. Largely as a result of this ill-timed, overpriced acquisition, RBS became one of Europe's weakest banks and was forced to undertake several highly dilutive capital raises. Now under new leadership and majority government ownership, RBS is narrowing its vision, turning around its core businesses, and shedding its legacy assets. We are starting to be impressed by the improvements that RBS has made in its core division.
Royal Dutch Shell (RDSB)
When viewing the oil majors' prospects, one key competitive challenge stares down each and every company: replacing reserves is becoming increasingly difficult and costly. To be sure, there's a lot of oil left in the world, but finding low-cost barrels of oil has never been harder, in no small part because many governments now don't allow Western oil companies access to their resources.
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