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Shopping for value during the downturn

Nicki Bourlioufas  |  20 Jul 2020Text size  Decrease  Increase  |  
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“US and Australian markets have come roaring back from oversold levels, but there are still pockets of value, given a sizeable amount of undervalued companies,” says Fleck, Morningstar’s head of equity research for Australia.

He points to Morningstar’s Global Equity Best Ideas list as a solid guide for retail investors.
“Roughly a third of coverage in both countries are either rated four- or five-star, and the average price-to-fair value ratio across both the US and Australia is slightly undervalued,” Fleck says. This compares with the average of extreme undervaluations in late March.

Well known Australian entrants to July’s list include Computershare (ASX: CPU), Westpac (ASX: WBC), Telstra (ASX: TLS), Woodside Petroleum (ASX: WPL) and Spark Infrastructure (ASX: SKI).

Stocks are added to the list when an analyst believes the prevailing market price offers a suitable margin of safety for long-term investors and Morningstar’s fair value estimate. Stocks are removed when that margin of safety diminishes. Often, the removal of a company follows a stock’s market price converging upon a stock’s fair value estimate, resulting in a three-star Morningstar rating.

Growing value-growth gap

Mike Aked, head of research in Australia for Research Affiliates, says share markets globally are divided down sector lines. “Technology and the most staple of consumer goods are doing well, banks and miners less so,” he says.

“Currently, your investment dollar will buy about double the earnings, book, sales or cashflow in Australia as compared to the US.”

Value stocks saw sharper falls at the start of the downturn and were also slower to rally.

“The current market rally is not based on economic fundamentals, but just liquidity trying to find a home, pushing the most expensive stocks higher,” says Aked.

AMP Capital’s head of global listed infrastructure, Giuseppe Corona, says the valuation gap between value and growth stocks is one of the widest ever recorded, comparable with that seen during the 2000 tech bubble. This supports Corona’s view that value stocks are relatively undervalued to growth stocks.

“We expect, on a global basis, value stocks to outperform growth stocks after this recession and we have been positioning our global portfolio accordingly.

In response, the AMP team has increased its exposure to cyclical sectors such as energy and transportation infrastructure and reduced its weighting to momentum sectors such as communication infrastructure.

Research Affiliates also tips value stocks to outperform. Current valuation levels imply that over the next five years, value stocks are poised to deliver an annualised excess return over the cap-weighted index of 1.2 per cent a year in Australia and 3 per cent a year in the US.

The gains would come after a long period of underperformance, with value stocks underperforming their growth counterparts by 50 per cent since 2007 in the US.

Much of the value-to-growth valuation gap has been fuelled by very strong gains in the FAANG growth stocks – Facebook, Apple, Amazon.com, Netflix, and Google’s parent, Alphabet.

In Australia, over the same period value investing has done better. Over the last roughly 13 years, the Australian large value portfolio generated a 0.8 per cent annualised return, surpassing the Australian large growth portfolio, which fell by 0.5 per cent a year. That led to 1.2 per cent annualised outperformance of value versus growth in the post-2007 period in Australia.

According to Aked, value stocks are well represented in the Australian market, which is dominated by large mining companies and big banks, which trade at relatively lower price-to-earnings ratios than technology and healthcare stocks, which have greater representation in the US market, notably made up by the FAANG stocks.

As growth stocks have rallied, gains in Australian stocks have lagged those in the US. As of 17 July, the US share market benchmark, the S&P 500, has lost just 2.3 per cent, compared to the S&P/ASX 200’s 10.6 per cent loss.

Emanuel Datt, managing director of the fund manager Datt Group, has run a screen over the stocks in the ASX200 index and picked those with the cheapest P/E ratios.
Datt comes came up with Yancoal (ASX: YAL), Cimic (ASX: CIM) and Fortescue Metals (ASX: FMG), which he describes as being “fundamentally cheap on accounting measures” though they have various risk factors that investors must consider when making an investment.

 Morningstar's Global Best Ideas list is out now. Morningstar Premium subscribers can view the list here.

 See also Morningstar Guide to International Investing

is a Morningstar contributor.

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