The UK stock market is in rotation. Is it too late to invest in value stocks?

Tej Kohli says that rotation has seen investors taking profits from frothy technology stocks and investing in under-loved ‘traditional’ dividend-paying stocks whose yield have become more attractive as their prices have steadily fallen in 2020.

The UK stock market is in rotation. Is it too late to invest in value stocks?

A new infographic by Visual Capitalist (see below) shows that typical IPO first-year returns in the USA during 2019 were -4.6% for ‘technology’ stocks, compared to an average IPO return for ‘consumer staples’ of 103%. Nearly $22bn was raised through technology sector IPOs in 2019 compared to just over $1bn for consumer staples. This reflects the strength of investor appetite for growth stocks, which continued unabated in 2020 and drove technology stocks to all-time highs.

Growth investing on this scale is not necessarily irrational exuberance.  Long established technology stocks such as Amazon and Facebook have shown that high return on invested capital companies stay high return on invested capital companies and do not diminish over the longer term. But many in the latest cohort of tech stocks are still yet to prove themselves. The rotation that we have seen during the last month in the UK and USA shows that investors are losing their appetite for waiting for growth from holdings which pay no dividends - especially now that more traditional dividend-paying stocks are looking so cheap.

Rotation is the counter movement of investor capital from one equity sector into another. Typically, it is a rotation between growth and value stocks. In the UK, this has seen investors taking their profits from frothy technology stocks with astronomical price-to-earnings ratios predicated on as-yet-unproven future growth, and investing in under-loved ‘traditional’ dividend-paying stocks, whose yield have become more attractive as their prices have steadily fallen in 2020.

The price of these stocks has been surging in the UK and USA in recent weeks, but that does not mean that it is too late to take a long position in value stocks. Many are growing from record low prices and, even after recent appreciation, are still looking cheap. One example is FTSE 100 stalwart British American Tobacco (LSE: BATS). With a current price of 2,733p, the forward-looking yield for the next year is just over 8%, and the stock remains much nearer to its 52-week low than its pre-crisis high despite the green shoots of some recent price appreciation. I predict a 50% appreciation to its pre-crisis levels in 2021, with the potential investment returns compounded further if you reinvest the 8% annual yield.

I’m also optimistic on another FTSE 100 stalwart in the form of Unilever (LSE: ULVR). Relatively speaking, the price has been stable during 2020 and, at 4,310p, is not far from its 52-week high of 4,944p. The COVID pandemic has proven how defensive FMCG and consumer staples have remained, and Unilever’s stable of brands and entrenched position across so many segments in so many markets leads me to believe that investors will flock back into Unilever as consumer staples start to look like a safe haven, with a reliable dividend yield of c.3%.

The third stock I’ll highlight today is Boohoo Group (LSE: BOO). The company has been marred by PR disasters during 2020 but has recovered its poise well and, at 309p, remains healthily buoyant from its 52-week low of 133p whilst still short of its high of 433p. Of course, Boohoo has the profile of a growth stock rather than a value one and pays no dividend. But the underlying business model is not rocket science. Boohoo has been stealing the lunch of its ‘value’ bricks-and-mortar competitors for a long time already, and with the collapse of Arcadia Group and Debenhams it is well positioned to capture a greater share of wallet.

So even though rotation has started to put some buoyancy back into the market for value stocks, do not be disheartened if you have not already taken some long-term value positions. It is not too late. There remains a lot of risk in the market from Brexit and the unknown economic fallout from Covid-19, so the prudence of being cautious is smart. It is certainly not too late to ‘get in’ on rotation with these very attractive UK value picks.

This post is based on Tej Kohli's regular column for The Motley Fool:

Tej Kohli is also an impact investor who backs growth-stage artificial intelligence and robotics ventures through the Kohli Ventures investment vehicle.  Tej Kohli is also the founder of the not-for-profit Tej Kohli Foundation whose ‘Rebuilding You’ philosophy supports the development of scientific and technological solutions to major global health challenges whilst also making interventions to rebuild people and communities around the world.  Tej Kohli’s blog is #TejTalks and he is also the author of Rebuilding You: The Philanthropy Handbook.  Tej Kohli posts on Twitter as @MrTejKohli.