Life as a UK equity manager hasn’t been easy of late. Our US colleagues have been singing the praises of trillion dollar tech stocks, our European friends are getting excited about a blockbuster German stimulus package, and even our emerging market peers are looking at the declining US dollar and rubbing their hands. Meanwhile, in the UK, we are stuck looking at a meagre growth backdrop and stubborn inflation.

However, if you were to judge the UK purely on market moves, you’d think the outlook for UK stocks was much worse. The discount of the UK market versus the rest of the world has been expanding for the best part of a decade, and is now the widest it has been for 50 years.

There have been many reasons for the widening in this discount, not least investors’ antipathy towards the UK economy. While we may not agree with the level of pessimism about the UK’s economic prospects, we don’t think this view should discourage investors from looking at UK companies from an investment standpoint. And certainly not at current valuation levels.

The UK’s global companies

Many UK-listed companies have significant international operations, offering investors exposure to global markets while benefiting from the stability of the UK regulatory environment. This means that UK investors can exploit the substantial valuation discount while also gaining exposure to the trends our colleagues from other regions are getting excited about, since that’s often where UK companies earn a significant chunk of their revenue.

The JPM UK Equity Income Fund employs a rigorous approach when it comes to selecting stocks, combining quantitative screening and on the ground, fundamental research. The current market environment provides a favourable backdrop for us to find internationally renowned companies, providing an attractive yield, at reasonable prices.

Generating income from UK stocks

The UK market has long been the go to place for equity income, with a strong history of reliable and consistent returns.

We view the landscape in three different buckets which combine to provide a powerful blend of both income and growth. These buckets are High Growth stocks, which tend to have a relatively low starting yield, but we think have scope to considerably grow their dividends over time. The second is Quality Compounders. These are stocks that sit in the sweet spot between dividend yield and growth, and which historically have offered the best absolute and risk-adjusted returns in our investment universe. And finally, we have the High Yielders category, which does what it says on the tin, provides the portfolio with a healthy yield, usually over 4%.

Cranswick serves as an example of a portfolio holding in the High Growth category. It meets this classification due to its consistent track record of achieving double-digit compound annual growth rates (CAGR) in revenue, pretax profit, and dividends over the past decade. The company has maintained steady revenue growth, with a 10-year CAGR of 10% and a five-year total shareholder return (TSR) of 44%. Cranswick's strategy, which includes vertical integration, premiumisation, and automation, has contributed to margin expansion, improving operating margins by 62 basis points over the last five years. Additionally, the company follows a progressive dividend policy, with 35 years of uninterrupted growth.

XPS Pensions Group is regarded as a Quality Compounder due to its consistent dividend growth and solid financial performance. The company has upheld a progressive dividend policy, increasing dividends annually since its listing, even during challenging periods such as Brexit and the pandemic. Furthermore, XPS has shown strong revenue growth, driven by high client demand and regulatory changes, while maintaining strong operational gearing and cash conversion rates. This record of steady financial and dividend growth aligns with the characteristics of a quality compounder.

NatWest Group is categorized in the High Yield segment due to its substantial capital returns, which include an increase in the dividend payout ratio to 50% and significant share buybacks, collectively providing a high distribution yield. The company has consistently shown strong capital generation, enabling attractive shareholder returns, with a total payout equivalent to an 11% yield in 2024.

Embracing opportunities in the UK equity market

While the UK equity market may appear overshadowed by global counterparts, it offers unique opportunities for discerning investors. Despite the widening discount and prevailing pessimism, UK-listed companies provide substantial international exposure and a strong track record of delivering attractive income.

The JPM UK Equity Income Fund leverages these advantages through a meticulous stock selection process, to capitalise on attractive valuations and ensure a robust blend of income and growth. As exemplified by holdings like Cranswick, XPS Pensions Group, and NatWest Group, the UK market remains a fertile ground for generating reliable equity income and achieving consistent returns.

The companies above are shown for illustrative purposes only. Their inclusion should not be interpreted as a recommendation to buy or sell.