In 2023, growth stocks in the UK and the US outperformed even though higher interest rates were supposed to hurt them. Growth shares in the UK outperformed value stocks by almost 30%, and many are expecting similar in 2024 as interest rates come down. However, now is the time that I’m looking at UK value shares more than ever.
Why I’m limiting growth shares
First, the general spiel for the case for growth stocks in 2024 is that interest rates would come down, changing valuations to be more attractive and making it easier for companies to borrow.
Although this isn’t false, the truth is that if the headline is already all over the Financial Times, then it’s more or less “priced in” by the market.
To truly outperform the market, you need to have an idea of what the market doesn’t fully expect or know.
Right now, it’s a given that interest rates in the UK and US would lower. Unless you are convinced that interest rates will fall further than what markets already expect – which is hard since experts get it wrong all the time – then it’s very likely that low interest rates would have a small impact on the share price itself.
In the US, growth stocks such as the “Magnificent 7” (Alphabet, Meta, Apple, Tesla, Amazon, Nvidia, Microsoft) have an average price-to-earnings (P/E) ratio of 49x, meaning investors are already paying quite the premium.
Most UK investors believe growth shares are the play in 2024. I’m taking a contrarian view and looking at value stocks where more growth opportunities could exist.
NatWest
NatWest (LSE:NWG) stands out to me as an undervalued stock.
First, though the conventional thought is that lower interest rates mean banks are less profitable, NatWest has already considered it and spun the situation as a positive.
Why? Because banks hedge against interest rate movements, meaning they lock in a rate to do business with from years prior. This makes sense since it would wreak havoc on the bank’s business if interest rates changed frequently.
Currently, NatWest still has interest rates hedged from 2019 and 2020. This meant it didn’t fully benefit from the rate hikes last year.
As old contracts expire and are reinvested into new ones, structural hedges will be a major revenue driver even if interest rates go down. RBC estimates that 50% of the bank’s income would come from structural hedges, totalling almost £5bn for NatWest by 2025.
The average UK banking P/E ratio already sits at just 5.1x, a historic low point. Meanwhile, NatWest trades at just a lower 4.44x P/E, giving it an almost 15% discount.
NatWest is investing in growth and succeeding. According to loveMONEY.com, the company brought in 59,158 net customers in Q3 2023, the most out of any other bank.
The biggest risk surrounding NatWest is that the UK government might sell its shares on the public market by 2026. This is concerning given that Bim Afolami plans to sell at a discount, meaning that NatWest’s share price would likely go down as a result.
For more cautious investors, it might mean waiting for more word on whether it would be sold to the public. For me, I believe NatWest shares have room to grow until then.
The post Why I’m investing in value shares over growth stocks even as interest rates are going down appeared first on The Motley Fool UK.
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Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Michael Que has no position in any of the shares mentioned. The Motley Fool UK has recommended Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
