Vaccine success, Biden’s election victory and what it all means for value investing
THE vaccine announcements by Biontech/ Pfizer and Moderna led to sharp gains by stock markets in the middle of November, but a closer look shows it was value stocks that enjoyed the best of the rally. Our analysis of companies’ cashflow characteristics suggest that these value stocks are still too cheap following their poor performance during the Covid-19 stock market sell-off earlier this year.
Value investing is the simple principle of buying shares that appear cheap based on historic or current measures of fundamental company value, such as earnings or assets. By contrast, growth-style investors will tend to rely more heavily on future estimates of growth in fundamental factors such as earnings; the companies they invest in will tend to look more expensive based on historic or current earnings.
The underperformance of value investing over the last few years has been well-documented. The MSCI World Value index has underperformed the overall MSCI World Index of developed market equities by more than 30 per cent during the last decade.
However, as news of a potential vaccine broke, there was a sharp rise in a number of value-style shares. But it is not only news of a vaccine that provides extra impetus to the value-investing case recently: the US presidential election results also provide a boost. One of the key implications of a new Democratic President is the potential for a significant infrastructure stimulus programme to be announced. This could be positive for sectors such as industrials, materials, consumer discretionary and financials, which appear to be the core of the stock market’s value cohort.
Furthermore, we have for some time been wary of the warning signals in “momentum” stocks – predominately growth-style tech companies. The vaccine announcement led to the biggest one-day momentum crash in history. Given the very high valuations of these stocks, we think they could continue to lag other areas of the stock market.
It is too early to say whether the recent rise in the popularity of value stocks marks the start of an extended period of good performance, but we certainly see positive signs.
The recent spate of third-quarter trading updates has given us reasons to be optimistic. A number of stocks we are invested in reported better-than-expected volume and pricing trends.
For example, Pandora, the Swedish jewellery retailer, announced double-digit percentage, likefor-like growth in several key markets and commented that trading in October was up 8%. In the autos sector, Peugeot saw better-thanexpected third-quarter revenues driven by improving volumes and positive pricing. UK housebuilder Vistry published a robust trading update including strong forward sales trends for the quarter ended September 2020 and commented that profits were forecast to be at the top end of the range of market forecasts.
The latest lockdowns may negatively impact fourth-quarter trading, but we would expect these positive trends to re-emerge once restrictions are eased.
While these qualitative observations provide some anecdotal support for investing in value stocks, our investment decision-making is always
based on rigorous application of our investment process, which is built around analysis of cash flows. This means we look only at actual cash generated by companies rather than relying on the profits they report – the two measures can be surprisingly different for a variety of accounting reasons. Encouragingly, this cash-flow analysis also points to a compelling opportunity for value stocks.
By our measures, there is a wide spread in share valuations between value companies, which tend to have high cash-flow yields because their share prices have been depressed, and growth companies, where share prices are elevated but cash-flow yields are low.
Value stocks have excellent backward-looking cash-flow yields as a result of strong historic cash generation combined with share prices that have been among the worst affected by the pandemic.
While many of these companies are currently enduring trading difficulties, we expect cash flow to revert to normal levels as economies recover from the pandemic. This should lead to a value rally that would close the large gap that currently exists to more highly-rated growth stocks.
Of course, it is difficult to predict the exact timing and magnitude of a sustained rally in value. The near-term economic outlook is very uncertain, which will undoubtedly contribute to bumps in the road for this economically sensitive investment style.
However, recent developments – medical, political and economic –should not be ignored. Has a new value-led market regime finally started to emerge?
Vaccine announcement led to the biggest one-day momentum crash in history