It has been a challenging first half for financial markets, with the economic and geo-political picture no clearer than it was three months ago. At the time of writing, the domestic political situation arguably adds further to the list of investor concerns. Whilst share prices have come under pressure, many companies are continuing to deliver solid updates, despite the current list of challenges. The strong operational performance of many stocks is not being reflected in recent share price moves as the market questions whether companies can sustain operational growth.
Despite some relief toward the end of the period, in the three months to end July 2022 the FTSE All-Share was down 1.2%, whilst the more domestically focussed FTSE 250 was down 1.9%, with the FTSE AIM All-Share down 9.5%. The relatively resilient performance of the FTSE All-Share against other benchmarks is largely a result of its high exposure to commodity focussed stocks, whose share prices reacted positively to the recent rise in the price of oil, gas and other commodities following sanctions being imposed on Russia. Sectors such as utilities and consumer staples, and cheaper ‘value’ areas like tobacco and financials have also performed better than the wider market as the market has moved more defensively and rotated away from some more growth focussed aspects of the equity market. Despite this sentiment rotation many growth companies have continued to deliver. Following this pull back in valuations, at current levels the UK equity market is now trading at a significant discount against both global developed peers, and against its long-term average. The below chart highlights that the UK is on its lowest valuation rating in 20 years. Whilst the question concerning the market is mid-term corporate profitability, many share prices are arguably already pricing in materially lower potential profits.
Mind the valuation gap
Growth equities have remained out of favour for the last nine months despite many companies upgrading profit expectations. Recent updates with investee companies suggests this robust trading continues with few companies reporting a slowdown in demand. This contrasts with share prices which have fallen steadily over recent months to the point that many companies across our mandates are now trading on price / earnings multiples which have not been seen since the Financial Crisis twelve years ago. Should companies continue to deliver profits in line with current expectations, then we would expect share prices to recover quite efficiently. The results season in September will provide further insight.
We continue to hold regular meetings with our portfolio companies. Despite demand holding up well, management teams are being required to manage the skills shortages, supply chain disruptions and inflationary pressures, some of which appear to have eased in recent months although will likely remain volatile in the short to medium term. Market commentators are now focused on global economic growth and the potential for a global economic slowdown. Whilst clearly conditions are challenging, we would highlight that navigating uncertain conditions is not new for many management teams; from the Great Financial Crisis to the uncertainty around Brexit, and more recently the impact of the pandemic, many businesses have proven adept at operating in the face of some adversity.
As an investment team we select companies which have certain characteristics. These include high levels of earnings visibility and recurring revenues, as these companies are less likely to disappoint on forecast revenues and profits. The team also targets companies that are leaders in their field of expertise, providing critical products or services. High levels of cash generation and a suitable capital structure are also critical, and the team expect the investee companies to be progressive in nature, so they focus on a company’s ability to ideally double profits within a visible timeframe. Whilst our investee companies will not be immune from macro factors, we focus our portfolios on those that we expect to be able to grow profitability, ahead of the wider market, through the cycle.
We continue to see positive newsflow from investee companies across a range of sectors, yet often where the stock price has disconnected with the strong growth fundamentals within the business. Names include MJ Gleeson, the housebuilder in areas of economic regeneration, where the share price is down over 30% year-to-date (YTD), despite recently delivering profits significantly ahead of consensus. Given the under-served nature of the market, we believe that this business should continue to benefit from excellent demand dynamics almost irrespective of the wider economic climate. Elsewhere there have been positive updates from Marlowe, the business-critical services and software provider, where earnings have grown by over 50% to financial year ended March 2022, yet the shares are down over 20% YTD. Midwich, the global specialist corporate AV tech distributor, which delivered first half profit growth of over 50%, and guided to full year performance to be ahead of previous expectations, yet the shares are down over 10% YTD. Brickability, the leading construction materials distributor, which delivered adjusted earnings growth of over 80% for financial year ended March 2022, and again guided to FY23 to be ahead of market expectations. However, yet again, the share price is down over 20% YTD and Next Fifteen, the global marketing, communications, and data business, which has delivered several upgrades to consensus estimates over the past 18 months, has seen its shares fall over 20% this year.
Also highlighting the value that exists amongst many growth companies is the recent 1925p cash bid for EMIS Group plc from UnitedHealth Group, the US Healthcare provider, at a 49% premium to the previous close. We suspect others will follow due to the combination of low valuations and Sterling weakness.
Cycles are a natural part of stock markets, and investor risk appetite can have a significant impact on share prices in the short term. What remains important is the performance of the underlying companies themselves. These are continuing to grow profits and dividends and are therefore creating value for underlying shareholders. This will be reflected in share prices once market sentiment improves. Whilst we are expecting the current market volatility to continue over the summer months, current share prices offer a very attractive entry point for those investors prepared to take a medium-term investment horizon.
At the time of writing, companies referenced within this article are held within Octopus managed funds and discretionary managed portfolios.
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Discrete 1-year performance % return to June
| 2022 | 2021 | 2020 | 2019 | 2018 | |
|---|---|---|---|---|---|
| FTSE All Share TR | 21.6 | 1.6 | 21.5 | -13.0 | 0.6 |
| FTSE 250 TR | -14.6 | 33.4 | -10.0 | -3.8 | 10.6 |
| FTSE AIM All-share TR | -29.0 | 42.5 | -2.8 | -13.9 | 13.5 |
| MJ Gleeson | -42.6 | 36.2 | -9.6 | -8.3 | 31.3 |
| Marlowe | -15.9 | 74.6 | 12.5 | -4.5 | 21.0 |
| Midwich | -0.5 | 47.3 | -30.6 | -12.6 | 102.0 |
| Brickability | -21.6 | 120.5 | n/a | n/a | n/a |
| Next Fifteen | -6.8 | 172.9 | -44.3 | 29.5 | 18.2 |
Risks to bear in mind
The value of an investment can fall or rise and you may not get back the full amount you invest. Smaller company shares are also likely to fall and rise in value more than shares in larger, more established companies listed on the main market of the London Stock Exchange. They may also be harder to sell.
Our investments are not suitable for everyone. We do not offer investment or tax advice. Personal opinions may change and should not be seen as advice or a recommendation. Before investing you should read the Prospectus, the Key Investor Information Document (KIID) and the Supplementary Information Document (SID) as they contain important information regarding the fund, including charges, tax and fund specific risk warnings and will form the basis of any investment. The Prospectus, KIID and application forms are available in English at octopusinvestments.com. The Authorised Corporate Director (ACD) of these funds is FundRock Partners Ltd which is authorised and regulated by the Financial Conduct Authority no. 469278, Registered Office: 8/9 Lovat Lane, London EC3R 8DW. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London EC1N 2HT. Registered in England and Wales No. 03942880.August 2022. CAM010999.
