Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 217

The potential for a value revival

The Danish philosopher Søren Kierkegaard observed that, “Life can only be understood backward, but it must be lived forward.” With the benefit of hindsight, events of the past often seem rational, even inevitable, yet the present is always fraught with uncertainty. This could also be said about investing.

Today’s investment climate could be summed up as cautious and noticeably bereft of conviction. While global equity markets have more than doubled from GFC lows, investors remain concerned about central bank policies, currencies and commodities, among other issues.

Even so, our company’s conviction in value investing is strengthening as we try to “understand the market backwards”.

What is value investing?

Value investing is a strategy where stocks are selected that trade for less than their intrinsic values. Value investors seek out stocks they believe the market has undervalued. These differ from growth stocks, which are companies whose earnings are expected to grow at an above-average rate relative to the market.

Value investors believe the market overreacts to good and bad news, resulting in stock price movements that do not correspond with a company's long-term fundamentals, giving an opportunity to profit when the price is deflated.

Valuation gap is extreme

Value stocks remain historically cheap relative to growth stocks. In fact, the valuation gap between value and growth stocks on a Price to Book value (P/BV) is at an extreme not seen for some time (see chart below).

Investors would have to go back to the height of the ‘dotcom bubble’ in 2000 to find such extremes. Back then, interest in tech stocks was enormous, based on their perceived growth potential. Today, it is the consumer staples sector that is attracting market focus as investors look for growth stocks that offer the perception of safety and stability in an uncertain environment.

Value on the rebound

One of the stronger catalysts for a value revival is rising interest rates. In the past, value cycles have occurred when rising interest rates have corresponded with a strengthening economy, although some argue it is the stronger economy and inflationary pressures that were the real drivers of the value revival. Today, however, global economic growth is moderate and deflationary pressures persist.

While value can be pro-cyclically correlated to the economy, this isn’t always the case. For example, investors waiting for an improving economic cycle would have missed the value upturn in 2000. Investors fleeing value in anticipation of economic weakness would have missed value’s outperformance during the recession of 1981-82. In each of these instances, we believe stocks simply became too cheap and a reversion to the mean prompted a value rally.

Rather than economic growth, we consider valuation of stocks a far more accurate predictor of future returns and a value recovery. When it comes to value, today’s valuation starting point is distinctly compelling.

Value moving beyond 'the usual suspects'

Since the GFC, value stocks have been primarily concentrated in either the resource sectors such as energy and materials or rate-sensitive sectors such as financials. For many, being a value investor has therefore meant taking on commodity risk or interest rate risk.

Recently, however, value has proliferated beyond just a few deep cyclical sectors to across the broad market. For example, value is just as cheap today within pharmaceuticals and biotechs as it is within financials and energy, as shown in the chart below.

The long-term trends for pharma and biotechs are encouraging given the ageing world population and increased wealth in emerging markets. Regulatory reform and drug pricing are clouds hanging over the industry but will not impact all companies in the same way. The best way to deal with a tough price environment is to innovate. We are invested in companies working on drugs for immune-oncology, gene therapy and Alzheimer’s which have huge potential. Current concern and uncertainty is allowing us to buy new stocks at what we believe to be a discount, and this is where the advantage of having a long-term horizon and patience comes in.

Long term view helps pick a bargain

Uncertainty is a fact of life and the road ahead is rarely obvious. One way to deal with uncertainty is taking a longer-term investment horizon. Many of the macro and political variables that drive markets in the short term are unforecastable with any reliable degree of certainty. However, long term valuations move reliably through cycles, as do economic variables like commodity prices and interest rates. Quantifying the potential impact of different scenarios on each of our holdings’ prospects and earnings and contrasting them with the company’s valuation allows us to judge whether we have identified a value bargain.

 

Peter Wilmshurst is Portfolio Manager of Templeton Global Growth Fund Ltd (ASX:TGG) plus a number of Templeton Global Equity Group's global portfolios. This article is general information and does not consider the needs of any individual.


 

Leave a Comment:

     

RELATED ARTICLES

Invest in Australian value stocks before it is too late

After 30 years of investing, I prefer to skip this party

Will value stocks benefit from the market's inflection point?

banner

Most viewed in recent weeks

$100 billion! Five reasons investors are flocking to ETFs

It's not official, but Australian ETFs are clicking over $100 billion right now. It's a remarkable rise, leaving the traditional rivals, the Listed Investment Companies, in their dust. Why are they so popular?

Invest in Australian value stocks before it is too late

By now, we know 'growth' stocks have outperformed 'value' for many years and investors look to the future, but there are good reasons why the switch is on, especially as value companies emerge from the pandemic.  

A close look at retiree fears and expectations

Half of Australians retire early due to unexpected circumstances and within timeframes they did not choose, and two-thirds of pre-retirees worry about funding their retirement. But neither are the greatest fear in retirement.

Minister Jane Hume on SMSFs and superannuation reform

Senator Jane Hume presented at the SMSFA conference this week, and we reproduce the full transcript as a guide to what the Government is thinking on superannuation reforms as we head into the next election.

Hume and Frydenberg reset super with two buzz words

The solutions to retirement problems are obvious. All we need are 'efficiency' and 'flexibility'. Learn what these two words mean and the future of superannuation policy is clear. Just don't tell Paul Keating.

Taxing the ‘rich’: the potential tax consequences of inequality

At some point, politicians will debate how to reduce the national debt and implement measures aimed at simultaneously easing budget pressures while reducing the gap between rich and poor. Investors should be ready.

Latest Updates

Superannuation

Hume and Frydenberg reset super with two buzz words

The solutions to retirement problems are obvious. All we need are 'efficiency' and 'flexibility'. Learn what these two words mean and the future of superannuation policy is clear. Just don't tell Paul Keating.

Investment strategies

How do women really invest?

It is often said that female investors are more risk-averse than males, but a closer look at the data suggest that income - rather than gender alone - may be the real determinant of women's investing choices.

Latest from Morningstar

Five lessons from the 'Witch' of Wall Street

Immersed in the business and finance worlds at an early age, Hetty Green became one of the most successful investors of all time. Her story shows that the best advice is often timeless.

Investment strategies

Why it's a frothy market but not a bubble

There are pockets of bubble pricing in some assets that can pop at any time, but overall, valuations are frothy but prices of most companies can be sustained if not hit by rising bond rates.

Investment strategies

Five factors driving the great Australian recovery

Australia’s economic recovery is expected to be strong in 2021. It may appear the local economy is lagging other countries as they recover but that is only because we are not starting from such a low base.

Fixed interest

How bonds may temper equity market disappointment

Equity valuations are lofty, but long bond rates have now returned to levels before the pandemic crisis. In a balanced portfolio, long bonds now provide more opportunity to cushion the volatility of equities.

Shares

Will rising bond rates hit your share portfolio?

After a strong rally since March 2020, markets are increasingly worrying about the threat of inflation and higher interest rates. Ironically, it might be at a time of strong economic growth which benefits companies.

Gold

10 key takeaways on gold, Bitcoin and the Elon effect

The rise of the Bitcoin price coinciding with a pullback in the gold price is leading commentators to argue the precious metal is being usurped by its purported digital counterpart. There's a long way to go.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use.
Any general advice or class service prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, has been prepared by without reference to your objectives, financial situation or needs. Refer to our Financial Services Guide (FSG) for more information. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.