Rational Exuberance - The Equitile Blog

24th May 2019

Posted by: Andrew McNally

Is the UK really going cheap?

Warren Buffett had juices flowing in the UK earlier this month when he announced that, despite Brexit, he was still looking to make acquisitions here. His comments were immediately seized upon as evidence that leaving the EU won’t impact Britain’s standing as a key investment destination. Moreover, it was the strongest endorsement yet, given Buffett’s reputation as a value investor, of the idea that UK companies have been left extremely undervalued in the wake of the 2016 referendum. Once Brexit is sorted, the logic goes, international investors will come flooding back to UK equities.

We are not valuation obsessives at Equitile – in practice value investing has been a tale of woe in the UK for a number of years – but we thought it worthwhile taking a close look to see if there are bargains to be had. Especially as the UK stock market has lagged the US significantly since the June 2016 Brexit vote – the S&P 500 is up 39% whereas the FTSE 350 is up just 18%.

Surprisingly, despite the 20% underperformance, general market valuations suggest only a marginal discount of UK equities relative to the US; the trailing Price Earnings Ratio for the FTSE 350 is slightly below 18 times earnings while the S&P 500 trades at 18.5 times earnings, down from approximately 24 times earnings one year ago.

Averages, as ever, only tell us so much and the distribution of value across each of these two markets paints a more meaningful picture.

The chart below shows the percentage of S&P500 and FTSE350 companies in each range of Price-Earnings multiple.


Although the distributions are not identical, a statistician would be hard pressed to prove the two distributions were statistically different. To our eyes it looks like the valuations of both the US and UK companies could have been sampled from the same population. 

That said it does appear, superficially at least, that the UK index has a higher percentage of companies with a Price-Earnings multiple between 10-15X, which could reasonably be categorized as ‘value’ companies. The S&P500, nevertheless, still has more than 20% of its constituents i.e. more than 100 companies, within this ‘value’ range so there’s no shortage of options to buy relatively cheap, low PER, companies in the US.

When adjusted for growth at the company level, the distribution tells a very different story. The second chart shows the distribution of Price-Earnings-to-Growth (PEG) ratios for the constituents of the two indices. Although the UK has a slightly higher percentage of companies with a PEG ratio of less than one, in the still modest 1-2X range the US offers a much higher percentage of opportunities.



Despite much talk of UK PLC being up for sale it doesn’t seem, adjusted for growth, that the UK stock market offers more value than the US. In fact, despite its higher recent returns, the US still offers more value at this stage.

The so-called home bias is a well know phenomenon that continues to distort the way investors approach the stock market. People tend to invest in what they know and so, if you’re sitting in the UK, it’s natural to spend too much time thinking about the opportunity that UK equities present. A report from Charles Schwab last year found UK investors are especially prone to the home bias with three out of four of them looking to invest most of their assets in the UK. Brexit, if anything, has accentuated this tendency by focusing attention on a region which in fact represents just 6% of the global stock market.

The US continues to provide the most dynamic and positive backdrop for investing. US economic growth maintains a long-term trajectory well above that in the UK – the most recent quarter showed annual growth of 3.2% versus 1.8% in the UK. Moreover, when adjusted for earnings growth, the US market offers more than enough value opportunities relative to the UK – despite Brexit.


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20th March 2019

Posted by: George Cooper

Splitting the water molecule

Technology is making the world a better place to live. We are living longer healthier lives due to technological progress improving our health, nutrition and safety. A case in point is the lifesaving technology of Intuitive Surgical, one of our favourite investments, whose robotic surgery technology recently saved the life of one of our clients. It’s worth taking a few moments to see just how advanced their technology is – video.

It is the constant process of innovation across a wide range of industries that leads us to be so optimistic about the future from both the perspective of investment returns and, more importantly, quality of life. In fact, we are so optimistic about technological progress that another of our clients tells us he uses Equitile for ‘outsourced optimism’. He invests with us to gain the benefit of the progress, which allows him to continue worrying about the dire state of the world!

To be fair, we must acknowledge all this technological progress has come at a price. Our improving quality of life is putting an increasing strain on the eco-system of the planet. If we are not careful the resultant ecological damage caused by our technology will more than undo its benefits. This is partially why we call this blog Rational Exuberance; we are exuberant about the future but, but we must keep the exuberance rational.

Global warming is clearly the biggest environmental concern today. But even here there are good reasons for optimism. The cost of electricity generated by solar power is now approaching that of fossil fuels, and by some measures it is even cheaper. The cost of solar power is expected to continue falling and bring with it a real possibility that within a few years it will become technically possible and economically viable to generate all our power from renewable resources.

Cheap solar energy is not the only practical barrier to a renewable energy economy. Solar panels may be able to generate cheap electricity, but they only do so slowly and of course only when they get sufficient sunlight. For this reason, improvements in energy storage technology will also be required to allow a full movement to renewable energy. At the moment we are reliant on battery technology for the storage of electricity and those batteries are both expensive and polluting to produce. For this reason, some see hydrogen technology as a preferable energy storage mechanism.

Solar energy can be used to split the water molecule into its constituent parts – oxygen and hydrogen – and the oxygen and hydrogen can then be recombined or burned, to give up the stored energy either as heat or directly as electricity. The beauty of this hydrogen-oxygen based energy system is that it is based entirely on abundant non-polluting renewable resources, water and sunlight. What’s more it is also based on real well-proven science, not some charlatan pseudo-scientific cold-fusion technology, reliant on breaking the laws of physics.

The technology to turn the dream of an endlessly renewable, non-polluting, hydrogen-based energy system into reality is still some way off. One of the most important missing pieces is finding an efficient, renewable and scalable, way to split the water molecule using solar electricity. Interestingly, in a recently published paper scientists working at Stanford university claim to have made an important step toward this goal. Their breakthrough is the development of a novel corrosion-resistant electrode allowing the generation of hydrogen directly from seawater. Researchers create hydrogen from seawater.

It is too early to tell whether this particular piece of research proves to be the vital breakthrough needed to kickstart a hydrogen fuel economy. Nevertheless, it is encouraging to see such exciting progress being made in this field. As investors we must always remember the economy is ultimately driven forward by innovation and, thankfully, there is still plenty of innovation around. We will be watching this area of technology closely both for potential investment opportunities and for potential threats to our existing investments.

We remain rationally exuberant.  

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8th March 2019

Posted by: Andrew McNally

Why I will now eat the fat as well

The highlight of my week was lunch with one of our investors who happens to be a medical doctor, a general practitioner to be precise. He’s one of those people in life that’s always willing to question conventional thinking and so our wide-ranging discussion on politics, economics and medicine threw up some fascinating analogies.

As I tucked into my lamb chop, he calmly asked why I was carefully dissecting the fat and shifting it to the edge of the plate. In all honesty, I wasn’t sure why but joked that I was staving off middle aged spread.

It set him off on a tirade about some of, what he thought, were the crazy ideas that had infused the medical world over the last thirty years - especially when it comes to diet. He recounted a story of another lunch he had at the start of what we now call the obesity epidemic. He noticed a colleague carefully separating the yolk away from his egg and, like me, leaving it to the side of his plate – it was the time when cholesterol as a cause of heart disease was going mainstream and so his colleague, clearly keen to avoid the cholesterol in the yolk, was determined to diligently follow the crowd.

The growing obsession with cholesterol and “fat avoidance”, our client argued, has left us feeling hungry and so much more prone to binging on starch in the form of wheat flour (he didn’t think there had really been a meaningful increase in sugar consumption over the last few years). He then went on to challenge, to put in mildly, accepted wisdom on the role cholesterol plays in heart disease.

The cholesterol obsession, he told me, really took off in the 1950s when an American scientist, John Gofman, claimed to establish a “clear link” between cholesterol and atherosclerosis. He in turn inspired a prominent nutritional scientist at the time, Ancel Keys, to conduct the highly influential Seven Countries Study which examined lifestyle, diet and cardiovascular disease amongst different populations.

One consequence of their conclusions is a $20billion industry in statins, a prophylactic drug now administered as standard here and elsewhere for anyone in their fifties with elevated levels of Low-Density Lipoprotein – so-called bad cholesterol.

The evidence from the 1950’s study is now being seriously challenged and is widely considered as flawed by today’s standards. In 2016 an international team of scientists reviewed 19 studies involving 68,000 people and found no link between high levels of LDL and heart disease in the over 60’s. In fact they found that 92 percent of over 60’s with high cholesterol lived as long as or longer than those with low cholesterol. The study went even further and argued that there was some evidence that high cholesterol levels may in fact protect against some diseases, even cancer, by binding to toxic microorganisms.

Our doctor client had his own theory. He pointed out that, historically, extended families in Mediterranean countries, where diet is often cited as low cholesterol, tended to stay together more than in the UK and the US, and so older generations had more young people around them. Numerous studies have cited loneliness as a key factor in heart disease in the aged.

The link between cholesterol, heart disease and the effectiveness of statins remains controversial (and it’s certainly not for me to offer a conclusion) but our client’s story makes an important point.

John Maynard Keynes is often quoted as saying “When the facts change, I change my mind, what do you do Sir?”. As is often the case, however, it’s not totally clear that Keynes actually used those precise words. A related but more reliable and useful quote comes from the American economist Paul Samuelson,  “When my information changes, I alter my conclusion”. “Information” includes more than “facts”, it also includes the analysis and interpretation of the facts, so even when the facts don’t change it’s perfectly reasonable, on further analysis, to change one’s mind.

The lesson? Keep analysing, keep questioning your interpretation and, most importantly, be willing to accept when you’re wrong.

Next time I have a lamb chop, I’ll make sure to eat the fat as well.

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