Where to find the best-value stocks in the market
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MoneyWeek Editor
John Stepek Dec 03, 2009
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Stock markets across the world are arguably now either at fair value or are over-valued, depending on which analysts you ask.
But just because bargains are harder to find, doesn't mean there aren't any out there.
Dylan Grice of Société Générale has just put out an interesting research note highlighting some stocks and sectors that he reckons still look good value. And among them are several sectors we've highlighted very recently...
How to hunt down cheap stocks
The basic idea behind value investing is that you find a stock which is undervalued by the market. In other words, the stock is 'worth' more than it's actually trading for. You build in a nice big margin of error – in case you get it wrong – then you buy it, wait for the market to revalue it, and take your profits.
Benjamin Graham is often described as the father of value investing. He was a huge influence on Warren Buffett among other well-known investors. Graham, in his 1949 book, The Intelligent Investor, outlined various ways of finding cheap companies. Probably the best known is the idea of buying companies that trade for less than the value of the assets they own. In other words, if you sold all the company's assets, you would end up – in theory – with more money than you'd paid for the stock.
But as Dylan Grice of Société Générale points out in his latest piece of research, that's not the only way to hunt down cheap stocks. The best companies make good use of the assets they've got to generate the best returns they can for their shareholders. In other words, they add value. Without getting too technical, Grice uses a model which looks at the value of a company's assets and the returns it generates from them, over and above what you could get from a bank account, say, to give an estimate of its 'intrinsic value'.
What Grice found is that if you backtest the strategy, then companies which traded at a big discount to this 'intrinsic value' measure, tended to outperform the ones that were priced more closely to their intrinsic value. In other words, the strategy worked.
So how might the strategy play out in today's market? Well, the first thing Grice found is that there aren't many bargains out there right now. In fact, the number of stocks passing his screen (those whose 'intrinsic value' is at least 50% above their current market cap) is at its lowest since the second quarter of 2007 – "the eve of the global credit crisis." So it's not a great time to be aggressively buying stocks.
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The best-value stocks in the market
But that's not to say there's nothing interesting out there. The most undervalued sector by this measure is the agricultural products sector, which makes intuitive sense. Agriculture looks cheap for various reasons – the prices of soft commodities haven't risen by anywhere near as much as their industrial counterparts in the recent rebound, yet the global population just keeps growing. With more mouths to feed, prices are likely to rise. More importantly, agricultural companies dealing in products that can improve yields and make farming more efficient will profit in the long run. My colleague Eoin Gleeson wrote about the sector and some of the top companies to buy, in a recent MoneyWeek magazine cover story on the next 'green revolution': Five ways to profit from the new agriculture revolution. Grice's pick in the sector, using his screen, is Hong-Kong listed Chaoda Modern Agriculture (HK: 682), which grows and sells fruit and vegetables in China.
Another name that stands out is pharma major AstraZeneca (LSE: AZN), a stock which we've liked for some time. Better yet, unlike Chaoda, Astra is paying a decent dividend yield of 5.1% for this year. We also like GlaxoSmithKline (LSE: GSK), which is on a yield of around 4.9%. However, if you have an appetite for taking more risk in the pharma sector, you might want to look at the research companies which are benefiting from big companies trying to cut their costs by outsourcing their research and development. You can find out more about these in the next issue of MoneyWeek, out tomorrow (claim your first three issues free here if you're not already a subscriber).
Thirdly, Grice's research suggests that various parts of the insurance industry - including reinsurance and life and health insurance - look undervalued. My colleague David Stevenson recently wrote about the bargains to be found in the non-life insurance sector - you can read more about them here: Here's where to find the cheapest stocks on the market.
Our recommended article for today
With consumers not spending and a heavily indebted government, the only way to expand the US economy is to export. And that's only possible with a devalued dollar. But in the short term, that could be disastrous for international trade.
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