about 3 years ago • 3 mins
The UK had a rough 2020: it was hard hit by the pandemic and exhibited the deepest downturn of any major economy. I hoped I might be able to spot an investment opportunity or two there as a result – and may just have come across a major one.
Like the rest of the world, the UK returned to economic growth in the third quarter of 2020. Unfortunately, however, fresh restrictions introduced in response to a resurgence of coronavirus late last year mean the country’s economy is likely to have shrunk again last quarter and continued to do so in early 2021 – plunging Britain into a double-dip recession.
But therein lies the opportunity, in my view. The UK’s ahead of the curve when it comes to rolling out coronavirus vaccines, setting its economy up for a relatively robust recovery. And given 80% of the UK economy is services-driven, that’s where I’d expect most of this bounceback to be reflected – especially since a big rise in the household savings rate suggests both pent-up demand and cash waiting to be spent.
I went looking for companies that could benefit from this spending – and came across an interesting document from investment bank Goldman Sachs. Goldman’s shortlist shows companies with >30% UK revenue exposure whose share prices are closely correlated with the UK’s services PMI – a survey of business activity. Put simply, these are the firms where you’d expect signs of an improving services sector to show up first.
These are by and large “cyclical” and “value” stocks: cyclical in that their fortunes are closely entwined with those of the UK economy, and value in that their shares look cheap compared to forecasted earnings – which have already started recovering from last year’s sharp declines.
One of the key themes we’ve consistently highlighted in these Insights is investors’ rotation towards value over growth (i.e. companies with fast-growing revenues and profits), as well as the opportunity cyclical stocks represent as economies recover. Goldman’s screen suggests how this might look in practice, at least in the UK.
A note of caution, though. The shortlist above should be seen as a starting point, not an end in itself. Due diligence is hugely important: for me, the next step is to assess the companies on their individual merits. Some of these stocks may well bounce when the services industry gets going again in earnest, but I’m looking for companies I’d be happy to own a slice of for years to come based on their financial fundamentals.
The biggest risk is a so-called “value trap”: you could end up buying into cheap-looking value stocks in the hopes of a recovery that either fails to materialize or just doesn’t benefit your investments in the way you thought it would. If that happens, you’ll be left stuck with shares of companies that aren’t on the trajectory you’d hoped for – and that may even have lost you money, especially relative to other investments you might’ve made.
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