Temple Bar: The Return of The Total Return Kings

Ian Lance, co-Head of Redwheel’s Value & Income team and co-portfolio manager, Temple Bar Investment Trust welcomes The Return of the Total Return Kings.

We, like most equity fund managers investing in the UK have spent the last few years trying to demonstrate how cheap the UK equity market is both in absolute terms but particularly when compared to the US equity market which is currently sporting one of the highest valuations ever observed.

Despite this, UK equities have continued to lag their US peers, whilst there have been many theories to explain the lacklustre returns of UK equities, my own feeling is that it is mainly explained by money flows. As we have discussed before, UK pension funds have spent decades not only selling equities to buy bonds but also reducing the UK as a percentage of their equity exposure. An additional factor has been the consolidation amongst the large wealth managers many of whom have moved away from allocating money on a regional basis to global investing. Since the UK has a 3% weight within MSCI World compared to the US weight of 70% (Source: MSCI World, 5 April 2024), this has also led to switching from UK equities. These factors have led to relentless selling of UK equities irrespective of valuation and on the other side, relentless buying of US equities regardless of valuation. When we highlight the very low valuations on offer in the UK equity market, we are asked, “what is going to change this?”. A fair question, since I find it hard to see a scenario where all the money that has departed the UK suddenly comes back in this direction. We can now see, however, two mechanisms that can potentially realise this value in UK equities without the need for large money flows into the market.

1.    Corporate takeovers

The relentless selling of UK equities has driven valuations to such low levels that overseas corporates have spotted an opportunity to acquire UK assets at prices offering potential to achieve an attractive return.

2.    Share buybacks

The CEOs of our investee companies are often baffled. They are doing a very good job of running their company yet continue to watch their share price fall. Our advice is to use the low share price to the advantage of the company’s shareholders by buying back shares at lower valuations. 

As we have previously highlighted, the poster child for a successful capital allocation policy that uses share buybacks is Next plc which has bought back two-thirds of its shares in issue since 2000 and hence produced a total return for investors of 16% p.a. and seen its share price rise from £5 to £80 over that time despite only growing sales at 5% p.a.

An even more spectacular example of the power of share buybacks has been British American Tobacco because investors rightly identified in 2000 that it had poor growth prospects due to the declining number of smokers. Between 2000 and 2016, its sales only grew by 2% p.a. and yet it gave its shareholders a 22% p.a. total return and saw its share price rise from £3 to £50.

We believe that the conditions today are reminiscent of those that existed in 2000; once more investors are focusing on the growth prospects of technology companies and are paying very high valuations for them in our view. Conversely, they have little interest in investing in old economy sectors such as energy, financials and autos and have driven the valuations of these parts of the market to lower levels.

We hope that it should be fairly obvious that if companies continue to buy back shares at the rate of the last two years, it seems likely that their share prices will eventually respond since their earnings per share and dividends per share could increase significantly. It is worth noting that share buybacks can sometimes have no impact for a while and then have a very marked impact when the market finally wakes up to what is going on.

We believe that the market is currently offering some potentially incredible opportunities for investors. Companies have the ability to use this low valuation to change the fundamentals of their business i.e. increase their earnings per share and dividends per share and that eventually the market will take notice of this.