Strategy

A new Jerusalem

Dividend increases and share buybacks are good news for UK equities according to our analysts – who think those dark Satanic mills could deliver world-beating total returns..

Josef Licsauer

Disclaimer

This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.

What if the UK market isn’t the forgotten backwater of global investing but instead the hidden realm where the next total return champions are quietly being forged? Picture an arena of dividends, buybacks, and capital growth, combining in a powerful alchemy, creating opportunities for those bold enough to seize them.

Sure, the UK is often labelled as a home to sluggish and out-of-favour industries, comprised of stocks that are overshadowed by the glittering tech titans across the Atlantic. But we think such labels fail to capture the dynamism simmering beneath the surface. Clinging to these perspectives risks overlooking a trove of undervalued and resilient opportunities, waiting for their moment to seize the gladiator’s rudis—the ultimate recognition of victory in the total return arena.

In this article, we examine how shifting market dynamics are reshaping the UK as a playground for total return strategies. Most importantly, we also highlight the investment trusts that have proven themselves in the heat of battle—armed not with shields and swords, but with disciplined strategies, attractive income and share buyback profiles, and a keen eye for uncovering value in a market brimming with potential.

Time to shift perceptions?

It’s no secret that UK valuations are languishing at historic lows relative to the US, with returns trailing far behind their transatlantic counterparts. This disparity has driven waves of capital outflows from the UK in recent years, as investors have chased the stellar performance of US tech giants. Simultaneously, we believe that many investors have also sought refuge in higher-yielding bonds and savings accounts amid elevated interest rates and economic uncertainty.

But history has shown, time and time again, that adversity often plants the seeds of opportunity for those willing to look beyond short-term market pessimism. One can’t help but draw on Warren Buffett’s timeless adage, be fearful when others are greedy and be greedy only when others are fearful. With UK equities overlooked and undervalued, could now be the time to embrace them?

Catalysts of change

Beneath the surface lies a diverse tapestry of resilient businesses that are benefitting greatly from the UK’s evolving dynamics. Many UK companies showcase strong fundamentals and a proven capacity to endure challenging macroeconomic conditions. We think that in many cases, not all, depressed valuations are less of a reflection of poor management or flawed business models but rather the result of prolonged economic headwinds.

One common critique of the UK market is its perceived lack of capital growth potential, even considering today’s valuations. There’s some truth to this, especially when comparing UK companies to their US equivalents. However, the tide may be turning. Key market fundamentals are showing improvements, as shown below, with stronger return on equity and reduced leverage, pointing to companies with greater profitability and healthier balance sheets. If this persists, the UK could be prime for a re-rating, as investors awaken to the long-term opportunities.

MARKET METRICS: FTSE ALL-SHARE

	current roe %	ten-year roe average	current net debt/ebitda (X)	ten-year net debt/ebitda average
FTSE All-Share	10.2	9.0	1.0	1.4

Source: Bloomberg, as of 15/01/2025

But here is where we think things get particularly compelling. The UK market is not only undervalued and showcasing improving fundamentals but it’s also energised by transformative catalysts, which could unlock significant value without the need for a flood of new capital. One such catalyst is the heightened corporate takeover activity, fuelled by depressed valuations that have transformed UK companies into attractive acquisition targets for international buyers. In 2024 alone, British firms worth £145bn were acquired—over half involving foreign entities. By year-end, deal activity had jumped 21% compared to 2023, underscoring the growing recognition of the UK’s undervalued potential. Many of these takeovers occurred at a premium to prevailing share prices, delivering, in some cases, substantial share price growth—a vital slice of the total return pie.

Building on this momentum, and chief among the catalysts, in our view, is the rise in buyback activity. Over the past year, nearly half of UK companies repurchased shares—the highest percentage among global markets. We think this is a clear signal that companies themselves recognise their undervaluation and are taking proactive steps to enhance shareholder returns. When executed at valuations below intrinsic value, buybacks can amplify shareholder returns, complementing the traditional income generated through dividends.

We think NatWest and Shell are prime examples. Over 2022 and 2023, NatWest repurchased approximately 10% of its shares whilst distributing dividends equivalent to about 12% of its market capitalisation. Shell, meanwhile, repurchased around 20% of its shares and paid dividends equivalent to roughly 10% of its market capitalisation. Together, these actions have delivered substantial value to shareholders in just two years—roughly 22% of market value for NatWest and 30% for Shell, or c. 11% and 15% annualised. Other players in the UK market, such as BP, Standard Chartered, and Barclays, echo this trend, embracing similar buyback and dividend strategies, helping support rising share prices in recent years. But for now, the two cases below help illustrate how buybacks and dividends can work harmoniously to deliver meaningful value to shareholders.

RETURNS TO SHAREHOLDERS

uk company	Two-year dividend paid (ex-special) (%)	Two-year share buyback return (%)	Two-year cash shareholder yield (%)
NatWest	12.3	10.1	22.4
Shell	10.0	19.7	29.7

Source: NatWest and Shell latest annual report 2023, Kepler calculations (two-year period covering 2022 & 2023).

Together, these catalysts unveil a market rich with opportunity, and several UK-focussed investment trusts are already reaping the benefits by backing UK companies leading the charge on delivering shareholder returns. Take CT UK High Income (CHI) . Manager David Moss views the current environment as a pivotal moment for the banking sector as many are now generating low to mid-teen returns on equity and rewarding shareholders with growing dividends and buybacks. Growing conviction here has prompted him to build up notable positions in the likes of NatWest (3.7%) but also HSBC (6.6% at the time of writing), attracted by their robust dividend profiles, share buyback programmes, and strong market positions.

Similarly, the broader energy sector is proving its potential. Managers like Imran Sattar of Edinburgh Investment Trust (EDIN) and Ian Lance and Nick Purves of Temple Bar (TMPL), know that whilst oil companies often face broader scrutiny, Shell is standing out for its evolving approach to the energy transition, as well as boasting a strong market position, attractive yield, and robust free cash flows. When combined with its disciplined capital allocation, which has driven high and growing returns to shareholders, these qualities have made Shell a key holding for both, with a 7.0% position in EDIN’s portfolio and a 5.8% in TMPL’s, as its current shareholder-focussed strategy and growth prospects align with their total return ethos.