With the market at all-time highs, are there any value stocks left? Or are we on the cusp of another downturn – in which all UK equities will suffer? Kevin Murphy, co-manager of the Schroder Recovery fund says the stock market may have exceeded the highs of 2000 and 2007, but company valuations have not.
“Looking at the market as a whole is not the best way to judge whether there is any value left in it,” Murphy explained today at the Schroders Investment Conference in London.
“The market is cap weighted, the level of the FTSE All-Share says nothing about the breadth of the opportunity set available.”
Murphy compared the outlook today to that in 2007, and found that on an average 12-month forward price to earnings ratio, the UK market does not look cheap, but it does not look as expensive as it did a decade ago either.
“Based on the cyclically adjusted price to earnings ratio we expect the UK market to deliver 3-4% a year for the next decade,” he predicts. “That might not sound like much but it is a lot more than you will get from any other asset class – and most other equity markets too.”
Although he remains confident in the value opportunity set in UK equities he admits it is easier to find ideas for the global fund, and that he has sold stocks – such as Tesco (TSCO) out of the global fund which he has been forced to keep in the UK fund.
Where are the Value Opportunities?
“Ten years ago, there was a lot of excitement around the mid-cap FTSE 250. Companies where taking on lots of debt and there was a lot of M&A activity. The FTSE 100 was much more boring, and cheaper, and we found the best value opportunities among the larger caps,” he said.
“However, a couple of stocks we invested in did not do well – Wagon, Yule Catto, Delta and HMV all failed, some losing as much as 100% of value.”
Despite these failures the fund still outperformed, delivering an average of 9.4% a year over the past 10 years.
But Murphy and his co-manager Nick Kirrage learned from these mistakes, and say that as well as valuation metrics they now consider more viligilantly the health of a company’s balance sheet before investing.
“Those stocks which tanked had weak balance sheets. So we are now very cautious about weak balance sheets,” he says.
Since 2007 the market collapsed, became very cheap and then rallied significantly. Murphy says that while there are more opportunities in the market now than in 2007 it is worth noting that the market is in a top 20% in terms of valuations. He adds: “We are treating the market differently now to in 2009.”
The FTSE 100 is once again the cheaper option to the mid-cap stocks, and he looks to those stocks which have had a share price drop of more than 20% year to date.
Provident Financial (PFG) stands out – after falling 66% in one day, Murphy has added it to the Schroder Recovery fund.
“We did not invest in a number of other stocks that have fallen significantly – Petrofac, Dixons/Carphone, BP and Indivior – because their balance sheets were not good enough,” he said.
Murphy says despite significant challenges, Provident made the cut because it has had high levels of profit in the past.
“We expect another profits warning, and an FCA fine,” he admits. “We have our eyes wide open. As value investors you have to be prepared to buy stocks that other investors find physically repulsive.”
