Choices, choices. The pool of shares on lower valuations is getting bigger by the day
It may not feel like the right environment to go shopping for stocks given market sentiment remains poor. Yet anyone prepared to look beyond the near term might find some great companies at more attractive prices than at any other point in the past two years.
This year has seen investors flock to value stocks where they could access profitable businesses on cheap valuations. Looking at classic value areas of the FTSE 350 year-to-date, the tobacco sector is up 24% and oil has risen by 23%. It might be time to turn your attention elsewhere and that leads to two obvious choices.
One is to look at higher growth stocks which have fallen out of favour. The other is to research lower growth stocks which may be even cheaper than before. Fund managers are certainly fishing around both areas with a view to picking up stocks that could generate good returns over the longer term.
‘It’s unusual as there are now opportunities in every kind of bucket,’ says Stuart Widdowson, fund manager of Odyssean Investment Trust (OIT). ‘We felt 12 to 18 months ago it was more interesting to look at self-help, recovery, lowly-rated stocks. But we’ve made a couple of investments over the past eight weeks or so in companies that are fantastic long-term compounders that have been thrown out with the general malaise that’s impacted equities.’
Widdowson is referring to new positions in camera equipment specialist Videndum (VID) which was formerly called Vitec, and gas springs maker Stabilus (STM:ETR). ‘Both are market leaders in their particular niche,’ he says.
Many investors have filled their portfolios with high growth stocks in recent years and this part of the market has been hit hardest in 2022. The question now is whether the derating we’ve seen in these stocks has resulted in some bargains.
Widdowson thinks there is another 10% to 15% derating, or more, to come before such growth stocks trade at more compelling valuations.
Simon Adler, manager of the Schroder Global Recovery Fund (BYRJXL9), says he’s recently looked at growth names like Alibaba (BABA:NYSE) and Meta Platforms (META:NASDAQ) and feels they are still too expensive when weighing up the potential risks and rewards.
He says many growth stocks are still ‘materially overvalued’, adding: ‘The vast majority of stocks that have fallen this year have gone from “mega loved” to just “loved” valuations. We like to buy things when they are hated.’
So, does that mean former market winners in the growth category will remain in the doldrums for months to come? Don’t bank on it. James Henderson, co-manager of Henderson Opportunities Trust (HOT), believes private equity could be looking hard at the sell-off in growth companies with quality characteristics.
He says private equity is flush with cash and may pounce on the recent depressed valuations in this space. Henderson believes quality stocks are more plausible takeover targets when markets remain choppy because private equity firms will want the reassurance of sound balance sheets and earnings growth today, not years down the line.
It takes guts to start buying shares when market conditions are so poor, yet history suggests this is precisely the time to strike it rich. Good luck in picking the right stocks.