The perfectly timed investment is bought low and sold high. It is also a near impossibility to execute. Even the professionals struggle to build the nerve to buy an unpopular asset and give up a stock which has made great gains.
But contrarian investing requires bravery – you have to be prepared to crystallise gains and risk missing out on a bit of upside. With that in mind, knowing a share’s fair value estimate can be, well, invaluable.
Morningstar equity analysts determine a stock’s “fair value” using discounted cash-flow which serves as the foundation for the Morningstar Rating for stocks. The current stock price relative to Morningstar’s Fair Value Estimate, adjusted for uncertainty, determines the Morningstar Rating for stocks. The Morningstar Rating for stocks is updated each evening after the market closes – one star means a stock is trading a level considerably higher than the fair value, three stars is on par, and five stars means it is significantly undervalued.
There are currently no stocks in the UK that Morningstar analysts rate one star, but there are eight with a two-star rating. We highlight three of them below.
United Utilities (UU.)
Much of Britain's water infrastructure is more than 200 years old and could require major upgrades during the next decade. Morningstar equity analysts project that United Utilities, which is one of 11 UK water utilities, will invest roughly £1.6 billion during the next two years in its water and wastewater system to address these needs.
Regulators in Britain approve capital budgets and utility rates once every five years based on utility budget forecasts. Utilities then must stay within that budget to achieve sufficient rates of return.
Sky (SKY)
Sky has succeeded in aggregating some of the best content available and then marketing its services. More than a decade ago, the firm began to enter exclusive deals to carry major sporting events in the United Kingdom. In addition, it acquired rights to many first-run movies and US-produced television series, which are becoming increasingly popular in the UK. While it resells the majority of its purchased content to other television carriers, it also produces its own shows to distinguish its product. The completion of a new production facility in 2011 has enhanced the company's content-creation capability.
The new building contains several studios, including one that is large enough to hold an audience and produce live shows, such as game or talk shows with a live audience. With the acquisitions of Sky Italia and Sky Deutschland, Sky is also producing and airing its own shows in these countries. This further distinguishes the firm from its competitors.
Reckitt Benckiser (RB.)
After shedding its pharmaceutical business, Morningstar analysts believe Reckitt is well-positioned to build on a solid 2014 by leveraging its brand intangible asset and enhancing its narrow economic moat. The household and personal care firm is refocusing its business on more health and hygiene products, which benefit from greater brand loyalty and higher margins.
In addition, efforts to extract costs from its operations should free up funds to ensure that it maintains adequate capital to reinvest in its brands.
Despite being a sharp operator with strong brands in some very niche categories, management seems to appreciate the importance of new products, which analysts view as crucial to keeping consumers loyal to categories and brands, particularly in this highly competitive space. However, they contend that even value-added new products can falter if consumers don't know about them, and as such, analysts view marketing spending behind the release of new products as essential.
