Few values left in global stock market

Morningstar US  |  20/03/2017Text size  Decrease  Increase  |  

Jeremy Glaser: After an eight-year market rally it should come as no surprise that there are an increasing number of questions about if the market is overvalued and if there are any attractive pockets left.

Recently, Morningstar's global equity research directors came together in Chicago, and we had the opportunity to talk to each of them about where they see valuations today and what some of their best investment ideas are.

Michael Holt: Globally, if we aggregate the price/fair value estimates, from of all our analysts, we come up with median value of 1.04. Now this is a number that's easy to misinterpret, but the simple version is, there are far more names that are overvalued than we're seeing that are undervalued right now. So, as an investor, you have to be far more selective and make sure you're doing your homework on every name you look at.

Now this valuation is not spread equally across all the sectors. We see a couple, like basic materials and the energy sector, where it looks even more overvalued than the rest of the sector, so you have to be even more selective and do your due diligence in those areas.

Last, I'd just like to add, make sure you understand when a stock is fairly valued, what does that mean? It means that we don't see the margin of safety we'd like to have as an investor to capture that capital appreciation. However, we do expect a 3-star stock, which is fairly valued, to deliver a total return in line with the cost of equity, so there is an opportunity cost to holding cash. So, take a look at the quality of the business. See if they have economic moats and see if you're protected if, through the cyclical nature of the market. That's how you can make good investment decisions.

Elizabeth Collins: Looking at the companies and sectors that the North American equity research analysts cover, we do see a lot of companies and industries that are overvalued. In general, we think that the market is pricing in a lot of optimism and not taking into account a lot of things that could go wrong in the future. Some of the things that are being priced in are things like deficit spending, increased spending on military, infrastructure increases, higher interest rates due to higher inflation expectations and lower taxes. While all of these things would be undoubtedly good for equity valuations, there are things that would come with the cost, and these are things like gridlock in Washington, D.C. might mean that these things don't come to fruition.

Similarly, there could be increased competition. Infrastructure spending that raises commodity prices would ultimately be met with new supply that drives down commodity prices. Likewise, lower taxes that benefit companies' bottom lines should ultimately benefit consumers in the form of lower prices in the absence of strong and sustainable economic moats. Given that, we do think that the market tends to be, in general, fairly valued, though we do see some sectors that have weaker valuations. Those sectors are communication services, real estate, healthcare, and consumer cyclical.

I'd like to give you a couple of our best ideas within the undervalued sectors. First, I'd like to talk about Roche. It's a biopharmaceutical company and they also have a diagnostics business. A lot of healthcare companies are facing the threat of cost containment, but this is actually a threat that plays into the advantages of Roche. Because of their in-house diagnostic arm, they have advantages when it comes to personalized medicine, which should lower cost, all else equal. They also have competitive advantages because of their biologics and the inability of competitors to replicate those biological innovations.

Another best idea that I'd like to talk to you about is Williams-Sonoma. They do the namesake Williams-Sonoma stores, also Pottery Barn and West Elm. This is a category that isn't facing a lot of headwinds, and we do think that the company has a narrow moat thanks to the intangible asset of their brand, which helps consumers decide that their products have higher quality and are worth spending money on. And we do think that they are ahead of their competitors when it comes to things like supply chain management, consumer analytics, and e-commerce. All said, we think that the market is being overly pessimistic about both Roche and Williams-Sonoma and they're two of our top picks in undervalued sectors.

Alex Morozov: Looking across to European equities, if you just look at it from a relative perspective, compare it for example to the US stock market, you can perhaps sense that the European market is relatively undervalued relative to the US It's not necessarily how we look at things, but that from a multiple perspective, European stocks do look a little bit cheaper. There are a couple of reasons, perhaps, for that.

Well, one, probably the most important one is that the growth in Europe is weaker than the US You still have a lot of countries that perhaps are not pulling their weight. Southern Europe is still not out of the woods. There's still a lot of concern about the general growth environment in Europe, and most European companies do have a bit of an outsize exposure to Europe as a continent.

And then a second way of looking at it--perhaps this is more of a headline risk, if you will--there's still a lot of uncertainty over political environment in Europe. Last year, Brexit was a major shock to the system. A lot of UK stocks have really taken a beating, and we still have a number of major political events in Europe that could provide this additional shock.

What we try to do though, we look at the companies that can and will have this sustainable earnings power that could survive whatever shocks the system's is going to provide. So the companies with economic moats are critical. Even though the European market as a whole is probably fairly valued, stock-picking is critical for us as is the case with all the analysts at Morningstar, but in an environment where you see a lot of fairly valued, perhaps even overvalued stocks, we still have a few interesting ideas in this space.

When we look at some of the top picks that we have, it's not surprising those are the companies with economic moats. My favorite name right now--especially considering that this is in the consumer staples space and consumer staples have run quite a bit a lot of the valuations are quite stretched, so not too many ideas that we have in consumer staples--but one that we do have is actually a wide moat, InBev, the largest beer manufacturer in the world. This is the company that last year completed his acquisition of SABMiller and with that, it became by far the biggest beermaker in the world.

The company has a few issues. It's exposed to emerging markets and when you are exposed to emerging markets, you are benefiting from perhaps higher growth in those areas, but you're also much more susceptible to some of the shocks that you see with emerging markets, whether it's currency, whether it's growth volatility, etc., but ABI has a very powerful business model, both given its size, its ability to extract pricing concession from its suppliers. Right now, it's trading about a 10 per cent discount to intrinsic value. It represents a really unique opportunity to buy this wide-moat business that rarely goes on sale.

The other ideas from Europe I have are in the aviation industry. One of them is the plane manufacturer Airbus. The other one is the aviation parts manufacturing company called Safran. Airbus has a narrow economic moat. Safran has a wide economic moat. Both benefit from a transition to the narrow body planes that we're going to see over the next 10, 20 years. Both are also companies that have gone under significant transformation, their operating model. We see a lot of upside in both of those companies. We see significant potential for margin uplift, earnings growth. Most importantly, those are the companies that regardless of what happens in Europe in terms of the political turmoil, weaker than expected growth, those the companies that we're confident and comfortable with our forecast for the next 15-, 20-plus years. And that gives us confidence in our recommendation of those two wonderful businesses.

Adam Fleck: We view the Australian market as particularly overvalued right now, trading at about a 9 per cent premium to our amalgamated fair value estimates. There's really a couple of key reasons for that. In Australia, of course, the financial services industry and the materials market make up the bulk of the tradable assets. In particular, we see commodities as overvalued right now. BHP and Rio are two of the largest that we have 1- and 2-star ratings on. And really, what has happened there is we continue to expect significantly lower commodity prices, particularly those that are related to the steel industry, over the long run as China's economy slows and rebalances, leading to a sharp fall in the several years to come.

So, it's really no surprise that we see the Australian market as overvalued right now. However, we still think there are some pockets of opportunity, especially as you look outside the materials space. They're somewhat few and far in between, but I wanted to share a few with you. The first, when you really look for undervalued names, you start to see some names that perhaps are not of the highest quality. One such name might be Ten Network. This is a no-moat company that we think has poor stewardship and very high uncertainty, but nonetheless trades at a 44 per cent price/fair value ratio, a substantial discount to our fair value estimate.

This is one of three commercial TV networks in Australia. And it's come under pressure recently as the company expects negative EBITDA this year, given some of the increased competitive pressure and pressure from the advertising market more generally. However, we're supportive of management's investments in content in this business. It's already paid off with some rising market share, up to 24 per cent from 21 per cent a few years ago. We expect that to get up to about 25 per cent over the long run, and see EBITDA returning to a positive long single-digit rate, which drives our fair value estimate.

If you start to look at 4-star names, you can see some opportunities and some higher quality stocks. One would be Brambles. This is a wide-moat stock that trades at 4 stars. It is the largest, global provider of pallet and reusable plastic crate pooling services. And unlike Ten, we think Brambles has a wide economic moat, based on its global scale and cost competitiveness and cost advantage. This is a business that's been hit hard from increased competition recently. It's also seen some inventory destocking at the customer level, and e-commerce has had some negative impacts as well. However, we see the company re-investing in its pallet quality. It's done so in the past. That's typically taken 12-18 months or so, but as it does that and feels the benefit of that longer term, we don't see a threat to the company's wide economic moat. And with retail sales continuing to improve, particularly in the US where this company has a nice presence, we see the market undervaluing the name right now.

Lorraine Tan: Return of risk appetite in Asia has led to a narrowing of upside gains that we see in equities. Having said that, we still think there are a lot of buying opportunities in selective stocks. There are also areas, whereby on a midterm basis, that will still benefit from some of the key themes and developments that will continue on for the next few years.

Starting with China, we look at that. A lot of the buy calls that we had in the financials and real estate space have run up but we still like the Industrial and Commercial Bank of China. The bad news over the past few years on the potential NPLs are still probably there, but we're seeing a uptick in macro activity, particularly on the infrastructure side, that should sort of alleviate some of the pressures going on for some of the financial institutions. In this regard, we thing there's still upside potential for ICBC on a midterm basis.

The other area that we're quite keen on in terms of the China policy developments is essentially factors that involve the environmental aspect, whether it's on the clean energy side or whether it's in terms of the reform that's going on in terms of tariff pricing for a number of the utilities and activities there. The key names that we like, we have a couple of ideas here. These include one of our best ideas, which is Guangshen Railway. We think the government will need to increase tariffs to help alleviate the debt situation for the former Ministry of Railway, and that will help improve the returns that companies like Guangshen Railway will see. The company's in a nice net cash position as well, so we think that's a relatively safe bet to have in a portfolio.

Companies such as ENN Energy and Beijing Enterprises, the latter being another best idea, will also benefit from situations of continued encouragement in terms of the gas usage in China as they move away from coal. That means also more reforms in terms of gas pricing and continued growth in terms of fairly strong growth in this sector and these companies are all enjoying pretty high returns on investor capital at this stage.

Turning to Japan, Japan has had a good runup, mainly because of the yen factor. But we are actually seeing some situations of companies actually benefiting from longer term corporate restructurings that are going on. We like in particular the Mitsubishi UFJ financial group. This is a bank, the leading bank in Japan, and the reflating story will definitely benefit MUFJ, and the fact that it's also still trading below its book value means that there's still some upside potential. It's got a fairly diverse global flow of revenue and we think that will also give the bank some additional opportunities in terms of driving loan growth.

For the rest of the other Japanese stocks, we also like Murata Manufacturing. It's for a longer basis in terms of its passive components. It not only gets a benefit from what's going on in terms of what's going on in terms of the smartphone demand, which will continue to grow in terms of LTE and 5G activities, but we think its movement in terms of the more passive components for the auto industry will also drive future demand for its output.

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Building a moat in foreign exchange
03/09/2014  OzForex’s low-cost, online business model could prove to be a meaningful market disruptor, and the shares look like a bargain today.
1 stock that's close to perfection
29/08/2014  Morningstar head of equities research Peter Warnes discusses results from the likes of Ramsay Health Care and Woolworths as the curtains close over the fiscal 2014 earnings season.
BHP, Wesfarmers and investor returns
22/08/2014  Morningstar's Peter Warnes takes a look at the latest results from BHP Billiton, QBE Insurance, as well as a "shareholder's dream," Wesfarmers.
Why moats matter
26/08/2014  Morningstar Australasia's co-chief executive Heather Brilliant talks about finding great companies in a new book she co-authored titled Why Moats Matter.
CBA stands out, Telstra gives back cash
15/08/2014  Morningstar's Peter Warnes takes a look at the latest earnings results from the likes of Commonwealth Bank, CSL, Telstra and ANZ, and gives investors an idea of what to expect from these companies going forward.
2 energy stocks with strong returns
08/08/2014  These two Australian energy companies should see strong returns over the next decade.
This wide-moat stock has been a star performer
05/08/2014  With its record of high profitability and very strong shareholder returns, this banking firm stands out.
Top investment prospects in 2014
16/07/2014  Morningstar's Peter Warnes explores the key issues, trends, risks and opportunities that lay ahead for investors over the next year.
Woodside, Santos in solid position
02/07/2014  Morningstar's Mark Taylor shares his views on future global energy demand and explains why Australia's major gas companies are well-positioned to benefit from favourable market dynamics.
Stockland poised for growth
30/06/2014  Stockland’s managing director Mark Steinert outlines the company’s growth strategy and gives his outlook for the housing sector.
Maximise quality, minimise risk
11/06/2014  Morningstar's Mathew Hodge shares some insights into the portfolio construction process, as well as the role of stewardship in stock selection.
Keeping bullish amid volatility
23/04/2014  Morningstar's Peter Warnes remains comfortable with his market forecast but still expects volatility to remain a constant companion.
Why moats matter
04/04/2014  An economic moat provides a gauge of a company's competitive advantages and overall strength, and it is a highly valuable tool for investors of all levels.
Getting a better deal on capital raisings
09/01/2013  A new service being offered by the ASX aims to give investors better access to capital raisings such as IPOs.
Huntleys' Forecast 2014
19/12/2013  Morningstar's head of equities research Peter Warnes provides an outlook on the key investment issues for 2014.
Are big bank dividends sustainable?
05/12/2013  At the recent Morningstar Individual Investor Conference, head of banking research David Ellis gives investors an idea of where he thinks the big four are headed in 2014.
Finding quality in resources
29/11/2013  At the Morningstar Individual Investor Conference, sector head of basic materials and energy Mathew Hodge shares his thoughts on where resources are headed in 2014.
Keeping faith in QBE Insurance
28/02/2014  Morningstar's Peter Warnes takes a look at the latest earnings results from QBE, Woolworths and Westfield Group and gives investors an idea of what to expect from these companies down the track.
Dividend upside for Rio Tinto
14/02/2014  Morningstar's Peter Warnes takes a look at the latest earnings results from ANZ, CBA, Telstra and Rio Tinto and gives investors an idea of what to expect from these companies going forward.
A buyback for BHP?
21/02/2014  Morningstar's Peter Warnes takes a look at the latest earnings results from the likes of BHP and Wesfarmers, and gives investors an idea of what to expect from these companies going forward.
Making money with Ian Huntley
21/11/2013  Veteran investor Ian Huntley waxes lyrical on healthcare stocks and specs, while also offering some simple but sage advice as we head into 2014.
Gail Kelly on Westpac's growth
14/11/2013  Westpac chief executive Gail Kelly talks to Morningstar about the growth outlook for the bank.
Gail Kelly on Westpac's growth: Part 2
19/11/2013  Westpac chief executive Gail Kelly talks to us about superannuation as a key growth driver for the bank in the second part of our interview.
Banking on big dividends
15/10/2013  Morningstar's David Ellis gives investors an idea of what to expect from three of the big four banks' upcoming full-year results, while also sharing some insights into a recent moat upgrade.
Does BHP have the edge over Rio?
17/10/2013  Morningstar's latest report compares the performance of BHP and Rio over the past decade.
Utility stocks and strong returns
08/10/2013  Australian-listed utilities have given investors a strong return in recent years and Morningstar's Adrian Atkins gives investors an idea of what to expect from these companies down the track.
Opportunities in Australian property
03/10/2013  Although property still offers opportunities, only a number of property sectors are well-placed to withstand industry pressures.
The shutdown's impact on the US economy
04/10/2013  A prolonged government closure could subtract half a per cent from US GDP growth based on the impact from the 1990s shutdown and the number of furloughed government workers today.
How safe is your money?
01/10/2013  Trust in our online broker is not enough. Investors need to understand how their money is being used when they invest and trade.
6 reflections after Lehman
17/09/2013  On the fifth anniversary of Lehman's collapse, Morningstar experts highlight the roles emotion, liquidity, leverage, and a sound gameplan played in the fortunes of investors through the global financial crisis.
Suncorp's focus on capital return
11/09/2013  Suncorp deputy chief financial officer Steve Johnston discusses the group’s capital management and growth initiatives.
5 gifts from Warren Buffett
04/09/2013  On the occasion of his 83rd birthday, we examine how the Berkshire chairman's principles help investors succeed, too.
QBE Insurance set for turnaround
23/08/2013  Morningstar's Peter Warnes lauds BHP's potash investment, while also affirming expectations for new management to turn around QBE's critical US and European operations.
Wesfarmers powers on after CBA "cracker"
16/08/2013  As the 2013 earnings season continues in earnest, Morningstar's Peter Warnes shares his thoughts on the results from Commonwealth Bank of Australia and Wesfarmers.
Telstra versus Rio Tinto
09/08/2013  As the full-year earnings season gets under way, Morningstar's Peter Warnes helps investors separate the wheat from the chaff.
What the bank levy means for investors
06/08/2013  What is the outlook for banks following the government’s decision to impose an insurance levy on the industry?
When's the right time to sell a stock?
04/07/2013  --
What to expect in 2014
26/06/2013  Huntleys' Your Money Weekly will shortly release its rolling six-month forecast and Morningstar's Peter Warnes gives investors an idea of what to expect as we head into the 2014 financial year.
The future News Corp
24/06/2013  Morningstar's Michael Corty looks at investor implications following the recent split of News Corp.
QBE Insurance poised for growth
11/06/2013  QBE is coming up on the halfway mark of its financial year and there are a number of external factors that bode well for the insurer, according to Morningstar's David Ellis.
Searching for sustainable dividends
03/06/2013  At the 2013 Morningstar SMSF Trustee Strategy Day in Sydney, Peter Warnes helps investors separate the wheat from the chaff when it comes to high-yielding equities.
Choosing high-quality companies
24/05/2013  Morningstar’s Mathew Hodge provides insights into what makes a business valuable for the long-term.
ASX and the retail investor
10/05/2013  ASX chief executive Elmer Funke Kupper talks about the market outlook, listed bonds, and why retail investor confidence is everything.
Can ANZ sustain its dividends?
09/05/2013  ANZ deputy chief executive Graham Hodges discusses the bank's recent dividend increase and its growth initiatives
BHP and Rio head to head
19/04/2013  After the big two miners released their quarterly production numbers earlier this week, Morningstar's Mark Taylor give investors an idea of which company put in the best performance.