UK shares have lagged their US counterparts over the past decade. For instance, the FTSE 100 managed a total return of 84% over the past 10 years.
That’s dwarfed by the 158% achieved by the US-based S&P 500. The tech-focused Nasdaq 100 managed an even more impressive 336%.
Part of the reason for this is due to the stocks that make up these indexes. The Footsie includes many financials, resources, and industrial shares. It includes few technology stocks. In contrast, many of the global tech giants are listed on the US indexes.
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And the technology sector has performed very well over the past decade, boosted by low interest rates and ample liquidity from the US Federal Reserve.
Time to shine
The UK has also suffered from much uncertainty and disruption after leaving the European Union. And one thing that stock markets don’t like is uncertainty.
But is now the time for UK shares to shine? It certainly feels like it to me. A lack of interest by international investors has left British stocks feeling particularly unloved.
That creates an excellent opportunity to buy cheap Footsie stocks, in my opinion. One measure I use to value investments is the cyclically adjusted price-to-earnings ratio (CAPE).
This is an improved version of the price-to-earnings ratio because it compares a stock’s price to its inflation-adjusted 10-year average earnings. I’d say it offers a more accurate picture of stock valuation.
Right now, I calculate the FTSE 100 CAPE as 16. That’s still below its long-term average of around 18. It’s also considerably below the S&P 500’s CAPE of 29.
With the Footsie looking undervalued, which shares should I consider?
The checklist
As a long-term investor, I’m keen on companies that I think will survive and thrive over many years.
More specifically, there are some criteria that I want my shares to have.
For instance, I look for a sustainable and strong competitive advantage. This is what Warren Buffett refers to as a moat. It could be a superior technology, patent, or brand.
Next, I prefer to see growing sales and earnings over many years. Although this is ideal, it won’t always be possible. Even some of the best companies are somewhat cyclical, and earnings can swing higher and lower.
One metric that I always look at when searching for quality shares is return on capital employed (ROCE). This ratio is commonly used by veteran investor Terry Smith. It calculates how efficiently a business can turn capital into profit. Generally, I prefer to see ROCE over 15%.
Finally, my ideal stocks must have a strong balance sheet. I like to see low levels of debt and high levels of free cash flow.
Which UK shares?
Several Footsie shares fulfil my checklist. But if I had spare cash right now, I’d load up on fashion retailer Next, mining giant Rio Tinto, and luxury goods business Burberry.
Although the near term is uncertain, these are high-quality businesses that should thrive over many years. But even in the long term, very little is certain. That means I’d need to monitor my holdings to ensure they continue to meet my criteria.
