Stock buybacks seldom deliver long-term value.
Acquisitions carry high risks and promise uncertain returns.
Yet evidence suggests that such extraordinary corporate activity is exactly what investors need to invest in the UK equity markets.
TheFTSE 100has bounced back in recent days, but is down almost 4% year to date. The UKs benchmark index has underperformed bothGermanys DAX (-2.5%) and Frances CAC 40 (-2.3%) so far this year. It has trailed both European indexes in the last couple of years, too.
Enter mergers and acquisitions (M&A). The UK is the most targeted nation in Europe, according to Dealogic, but outbound activity is subdued. In 2013, for instance, outbound M&A volumes in the UK stood at about $16bn, or about 30% of the total inbound activity. That was the lowest level for about 20 years.
TheS&P 500trades at record highs and is up 10% in 2014. Notably, the S&P 500 has registered a +8% performance since mid-October and has surged more than 40% in the last two years.
Japans quantitative easing and reassuring statements from the Fed helped a lot in recent days, but thats only one part of the story.
Either shares on this side of the Atlantic are too low, or the shares of US companies are too high. Easy, right? Rather, you may wonder whether the US economy and its financial markets are decoupling from the UK and, more broadly, from Europe.
So, will recent trends be confirmed?
US stock markets deserve a premium, for the US economy is growing at a much faster pace than the rest of the Western world. But there are also signs that financial engineering is making a difference, and UK companies should be more aggressive on that front to narrow the valuation gap against their rivals in the US.
Thin On The Ground
Take the industrial sector.
In the UK,Rolls Roycerecently disappointed investors. It trimmed guidance for its energy and nuclear division and its shares plummeted. Rolls stock surged earlier this year, however, when Rolls announced it would invest proceeds from disposals in share buybacks. Elsewhere,BHP Billitonstock was hammered during the summer when it became apparent that the miner wouldnt return excess cash to shareholders via buybacks.
In the US, the equityvaluation of several US companies, fromFedExtoIngersoll-Rand, have been boosted by stockbuybacks in recent weeks. Elsewhere,General Electricrecently raised guidance and delivered value to shareholders, but its shares have benefited from M&A activity. The US behemoth received today the green light from the French government to complete its $17bn acquisition ofAlstoms energy assets.
Such extraordinary corporate activity remains thin on the ground in the UK.
The Fed painted a brighter outlook for the US economy last week: interest rates will rise sooner rather than later. Of course, what the Fed didnt say is that financial engineering, rather than heavy investment, is back on the agenda as tapering fades away.
According to research from data provider FactSet, trailing 12-month US stock buybacks grew 29.4%, but this growth rate compares with a decline of 0.5% in free cash flow generation. Not only buybacks relative to free cash flow hit the2008 levels, but the ratio continues to rise. in 2014, it reached the highest level (82.2%) since the third quarter of 2008, according to FactSet.
The immense US cash pile is being spent, apparently. This year recorded the first decline in US companies cash reserves since the Association for Financial Professionals began conducting the survey in 2011, Reuters recently reported, adding that, according to US data on durable goods orders, not much of cash has gone to buying plants and equipment.
US companies arespending more cash on acquisitions and buybacks, which were responsible for significant earnings accretion at a larger number of companies than in previous quarters, according to the Wall Street Journal.
And the UK?
Well, theUKs benchmark indexhas disappointed many investors in the last couple of years, and may continue to do so for some time, unless, UK-listed companies consider alternative ways to allocate capital. With all the risk that such a strategy may bring
Ifyou are keen to invest in the UK, you should learn more about a few investment opportunities: companies that could offer 20%+ upside in the wake ofM&A and buybacks activity. We have sighted a couple of stocks that have delivered terrific value to shareholders for two decades!
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Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.