Best UK companies to invest in

UK stock markets performed strongly in the first half of the year as the country prepares for elections that will lead to a new Labor government. But the recent budget has sent stocks lower on concerns about inflation and slowing growth. The combination of Trump's victory and a stronger dollar continued to send UK shares falling.

Some investors see low stock prices as a buying opportunity, but it's important to separate low-quality stocks from stocks that are high quality but trading below fair value. There are a few ways Morningstar looks at valuations to identify opportunities. Does the stock have a competitive advantage over its competitors? Do you know how to best manage your cash flow? How likely is the stock price to move around this valuation estimate?

We've identified 16 stocks that fit these criteria. Currently, 8 out of 16 stocks are undervalued. Stocks highlighted in this article include:

GSK GSKRentokil early RTOSpirax SPXMelrose Industries MROBBritish American Tobacco BATSReckitt Benckiser Group RKTAstraZeneca AZNBAE Systems BA.Diageo DGE

Undervalued UK stocks to consider

GSK GSK

Fair Value Per Share: 22.00Morningstar Rating: ★★★★★Morningstar Uncertainty Rating: Mid-Capital Allocation Rating: Standard

The most undervalued stock on this list, according to Morningstar metrics, is GSK GSK, one of the world's largest pharmaceutical companies. New products and an extensive list of patent-protected drugs are key reasons why GSK has been given a wide economic moat rating.

One of GSK's strengths is its focus on innovation, particularly in oncology and the immune system, using genetic data processing to have stronger pricing power and increase approval rates.

After the U.S. election, Morningstar strategist Karen Andersen noted that the biopharmaceutical industry could expect mergers and acquisitions to become easier, and the potential repeal of parts of Medicare could ease pricing pressures on the industry. But approval decisions for drugs, especially vaccines, can become difficult to predict.

The stock price is currently trading at 13.10, a 40% discount to the fair price.

Rentokil Initial RTO

Fair Value Per Share: 6.20Morningstar Rating: ★★★★★Morningstar Uncertainty Rating: Mid-Capital Allocation Rating: Exemplary

Pest control and commercial hygiene company Rentokil RTO is currently trying to turn around its struggling North American pest control business and is struggling to achieve growth along with the rest of the market. But after October's third-quarter update, Morningstar's chief equity analyst, Grant Slade, believes stock picking remains attractive and investors' low confidence is an overly pessimistic view.

Rentokils strategy is focused on gaining and maintaining market share leadership through mergers and acquisitions, which continues to be a priority. This strategy has provided sustained cost advantages for Rentokils pest control business, the source of a wide economic moat rating.

The stock is currently trading at a 35% discount to its fair value, and its stock price is 4.04.

Spirax SPX

Fair Value Per Share: 96.50Morningstar Rating: ★★★★★Morningstar Uncertainty Rating: Mid-Capital Allocation Rating: Standard

Spirax SPX, an industrial producer of thermal systems and biopharmaceutical tools, has recently experienced a slowdown in performance. But Matthew Donen, senior equity analyst at Morningstar, believes this is a cyclical recession limited to a few sectors and China.

Morningstar remains confident in the company's fundamentals despite recent management changes and recent acquisitions. Based on consistent capital returns and half of its revenue coming from recurring maintenance, analysts have assigned a fair value for the company's stock at 96.50. Spirax's stock price is 65.50, 32% below fair value.

Melrose Industrial MRO

Fair Value Per Share: 7.40Morningstar Rating: ★★★★★Morningstar Uncertainty Rating: Mid-Capital Allocation Rating: Standard

As an engine and components supplier, Melrose MRO is a long-term partner with all engine OEMs such as Pratt & Whitney, GE, Safran and Rolls-Royce. Morningstar believes the company is strongly positioned to benefit from the post-pandemic civil aerospace recovery, growth in the engine aftermarket segment, and upward trends in civil and defense markets. Both operating profit and margins increased last earnings season, and Morningstar expects strong defense sales through spending in both Europe and the United States.

Melrose closed at 5.27 on November 18, trading at a 29% discount.

British American Tobacco Bat

Fair Value Per Share: 39.00Morningstar Rating: ★★★★Morningstar Uncertainty Rating: Mid-Capital Allocation Rating: Standard

Globally, cigarette sales are declining by about 5% per year, but British American Tobacco BATS is able to maintain a wide economic moat rating due to the addictive nature of its products. Moreover, Morningstars analysts believe the U.S. market is attractive and expect BAT to continue to be able to raise prices to offset volume declines and promote solid free cash flow generation.

The stock was trading at 28.82, a 26% discount.

Reckitt Benckiser Group RKT

Fair Value Per Share: 65.00Morningstar Rating: ★★★★Morningstar Uncertainty Rating: Mid-Capital Allocation Rating: Standard

Reckitt Benckiser RKT is a leader in consumer hygiene, health and infant nutrition products. However, the company suffered from leadership changes and lawsuits over its premature infant formula product, which fell out of favor with investors. But after winning the lawsuit, the stock rose 10% in early November. Morningstar equity analyst Diana Radu argues that while a lawsuit victory would go a long way in restoring confidence, the overall majority of Reckitts' portfolio is well-positioned to benefit from long-term growth drivers.

Reckitt is trading at a 26% discount to fair value at a stock price of 47.83.

AstraZeneca AZN

Fair Value Per Share: 124.00 Morningstar Rating: ★★★★Morningstar Uncertainty Rating: Mid-Capital Allocation Rating: Exemplary

AstraZeneca AZN is the second largest company in the FTSE 100 by market capitalization. AstraZeneca AZN's patent-protected drugs and development pipeline, one of the strongest in the industry, add to its wide moat rating, according to Morningstars analysts. Our analysts also view Astra as a company with a healthy balance sheet, strong investment performance, and generally fair shareholder distributions.

AstraZenecas' current share price is 99.15, which is 20% below its fair value.

BAE Systems BA.

Fair Value Per Share: 14.90Morningstar Rating: ★★★★Morningstar Uncertainty Rating: Mid-Capital Allocation Rating: Standard

Wide moat BAE Systems BA. It has achieved strong performance with an average annual return of 34% over the three years since the outbreak of the war in Ukraine. The defense industry is more difficult for new players to enter the market due to technical knowledge, patents, and strict laws. Rising global security concerns are accelerating structural growth in the defense market. Morningstar expects global security concerns to continue to drive growth for at least a few more years. BAE Systems is strategically positioned to benefit as it holds significant stakes in a wide range of major international defense projects.

The stock price was 12.96, undervalued by 13%.

Diageo Governor-Elect

Fair Value Per Share: 31.00 Morningstar Rating: ★★★★Morningstar Uncertainty Rating: LowCapital Allocation Rating: Standard

Morningstar recently lowered its fair value estimate for Diageo DGE, which owns more than 200 alcohol brands, due to a post-COVID-19 demand reset. Morningstar believes in the company's premiumization strategy that capitalizes on the consumer trend of drinking less but enjoying more. With brands such as Johnnie Walker, Diageo has scope for some of the key brands in its portfolio. However, due to the cyclical nature of the industry, receiving returns on premium investments may not be linear.

The company's stock price is 23.61, trading at a 9% discount to fair value.

What makes the best company?

Margaret Giles

One of the keys to finding the best long-term investments is buying companies that give you a leg up on the competition. Legendary investor Warren Buffett originally coined the term economic moat to refer to a company's ability to fend off competitors over time. Morningstar builds on these ideas and evaluates companies based on their moat, or the strength and sustainability of their competitive advantage.

We've compiled a list of the best companies available on the London Stock Exchange that are covered by our analysts. These companies have successfully created wide moats with their industry competitors and are confident that they will generate returns that exceed their costs over the next 20 years or more. This means that these companies will be able to generate stable returns for investors over the long term while investing for growth.

The companies on our list also have predictable cash flow, or money coming in and out of the company, which allows analysts to more accurately estimate the company's value. These companies also make smart decisions about how they manage and invest their money.

We're not advocating you buy stock in every company on this list today. Even the largest companies can be bad investments if they pay too much. The stock prices of many of the companies on this list overstate their true value, so now may not be the right time to buy. Nonetheless, we believe these companies are worth adding to stock investor watchlists.

We've grouped the companies on this list according to the overall sectors of the economy in which they compete.

Create your own stock recommendation list

Readers of Morningstar.co.uk can use Morningstar's unique suite of tools to create a list of company picks for their portfolios. This allows you to cross-reference your ideas with Morningstars' own extensive research database.

Visit this article to learn more about deploying Morningstar data to enhance your own asset, fund, and portfolio selection process.

The author owns no shares of any securities mentioned in this article. Learn about Morningstar's editorial policy.

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