Stock market crash? No, British shares are 15pc undervalued – Telegraph.co.uk

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Despite posting rapid gains over the past year, shares are substantially cheaper than their long-term average, according to one popular measure.

Since the EU referendum result the FTSE All Share index – which broadly represents the British market – is up by 26pc. The rise has in part been fuelled by a weakened pound boosting earnings from overseas, and many have questioned whether the rally is likely to continue.

On a simple price-to-earnings ratio, looking at the value of the share price compared to companies’ earnings, the market does appear to be more expensive than history. However, this has been affected by temporarily weak earnings from oil and mining companies, which should recover now that commodity prices have risen.

Looking at a longer term measure – cyclically adjusted price-to-earnings (Cape) – the UK market appears much cheaper. Cape compares price to average annual earnings over the past 10 years, adjusted for inflation.

For instance, if a company has average annual earnings per share over the past 10 years of $1, and the share price is $10, its Cape value would be 10. This methodology can be used to value whole markets.

Since 1983, the FTSE All Share has averaged a Cape score of 16.9, but at the end of June it was 14.6, according to JP Morgan Asset Management.

This is despite the 10-year time frame including the global financial crisis, when company earnings suffered heavily. This would be expected to push down the average annual earnings figure, pushing up the Cape valuation.

James Illsley, a fund manager at JP Morgan Asset Management, said that investors’ fixation on how much shares have climbed “missed the point that the UK market overall is cheap”.

The table below, using data from German investment firm Star Capital, shows how the UK’s valuation compares to a selection of other world markets. The US, at a Cape value of 28, is nearly twice as expensive. 

Despite the data, not all professional investors are optimistic about the outlook for the UK market. 

Anthony Rayner, a multi-asset manager at Miton, said this week that he is steering clear, and described the UK as “an empire already declined and struggling to find its way post Brexit”.

Investment manager Brooks Macdonald said in its latest market overview: “Sterling’s devaluation has caused inflation to rise above the level of wage growth, pressuring consumption – a major driver of the UK’s overall growth.”

Due to this, the firm has downgraded its view of domestically focused stocks.