The FTSE 100 hit an all time high a few weeks ago, but since then, worries around the financial sector are brewing, inflation is still around, and investor confidence in the UK seems low. So how is this reflected in the market?
As we’re nearing the end of the first quarter of the year, now is a good time to look at the most expensive and cheapest stocks in the UK. Are there any attractive areas to invest?
It’s no surprise that the most undervalued stocks are found in the consumer space, with a tilt towards online services. These stocks all have high or very high fair value uncertainty. That means means they must be trading with a bigger discount (or have a 5-star rating) than their counterparts with low fair value uncertainty to be considered undervalued.
At the moment, 11 stocks are trading in 5-star territory, and four of these are trading at more than 50 discount to their fair value.
The Cheapest UK Stocks
Both Asos (ASC) and Ocado (OCDO) are currently available to buy for around a quarter of what Morningstar’s analysts consider them to be worth. Over the past one year, the stocks are down 54.01% and 64.68%, respectively.
AJ Bell’s investment director Russ Mould explains: "the funding environment for technology and start-up companies is certainly looking a lot less healthy and focus may start to turn to the asset managers and private equity funds which are invested in these firms."
This sentiment seems to be reflected in our data. When we look at the top 10 most undervalued stocks, we also find two financial services firms – insurers Admiral (ADM) and Direct Line (DLG) – trading at roughly 40% discounts.
This is no surprise – after all, Direct Line issued a profit warning and cut final dividend earlier this year, which predictably led to a share price tumble and a CEO exit. Following this, Admiral also cut dividends by 40% and increased its prices to protect profits, much to investors' dismay.
Henry Heathfield, analyst at Morningstar, argues that the market might have overreacted to the 2022 report: "while on the surface Admiral’s balance sheet appears to be weak, in reality this is because of the growing operations of Admiral Loans.
"While [the numbers] are a little off our forecasts, we think shares remain undervalued."
Overall, the FTSE 100 index has taken a tumble since the start of March. The index had been steadily growing since October, around the time we last changed prime minister. Overall, the index is still up 6.43% since this time last year.
The Most Expensive UK Stocks
At the most expensive side, we find the usual suspects: defence, utilities, and industrials. Rolls Royce (RR.) is the most expensive stock available today, trading at a 38% premium, followed by BAE Systems (BA.) at 30%.
That said, not a single UK stock is trading in 1-star territory, meaning even the most expensive stocks are only slightly overvalued. Rolls Royce is the only company in the top five with a very high fair value uncertainty, while the rest are medium or low. Moreover, only nine stocks in total are trading at a premium.
A Look at Rolls-Royce
What’s behind Rolls-Royce’s growth? The stock is up 55.06% over the past one-year period (the highest return among our rated stocks, followed by BP’s 50.52%). The company struggled during Covid-19, but after initiating a £1.3 billion restructuring programme and a new CEO, the company reported higher 2022 revenues and profit than forecasted.
According to Alec Cutler, manager of the Orbis Global Balanced fund, the company’s new management is driving it towards a focus on commercial success.
"Rolls-Royce has been fantastic for us," he says.
"[The company] is famous for making amazing pieces of equipment, not charging enough for them, and then making amazing equipment that nobody asked for. And they’re finally making them more commercial."
The war in Ukraine has also helped drive up the share price, as the group is also a major developer of jet engines and nuclear reactors for submarines. However, Morningstar believes the invasion poses fresh challenges for the group as the global aerospace supply chain is dependent on Russia for raw materials.
Cutler, on the other hand, sees potential in the nuclear reactor space: this week, a $368 billion deal between the UK, US and Australia was reached to acquire a fleet of up to eight nuclear-powered submarines. Rolls-Royce is providing the reactors.
The technology goes beyond submarines, too. "The government is now asking them to turn [the nuclear reactors] into small reactors – the new cool thing is to put small reactors all around the UK to boost electricity," Cutler says.
The Market as a Whole
On average, all but one sector is undervalued at the moment. As mentioned, the biggest discounts are found in the consumer cyclical sector, which averages a discount of 32.34%. Meanwhile, industrials are currently trading at a modest 2.61% premium.
According to Cutler, some of the lack of returns is down to a lack of interest in domestic stocks in the UK.
"With the quality of management, the quality of their business, the level of business activity, beating their earnings, positive earnings revisions; anywhere else in the world, the stocks would be doubled."
He notes that his fund owns Headlam (HEAD), bought at a discount, but if the stock price over time remains disconnected from its growth, Orbis would be advising the company to move their listing from London to New York.
"Our job is to our clients. It’d be terrible for the UK if all the good domestic companies left for New York, and something has to change."
