We’ve scoured the globe looking for the most undervalued stocks under Morningstar coverage. These companies are the cheapest of the 5-star stocks, the most extreme end of our valuation scale.
Many stock markets worldwide have reached record highs in August, but there have been some notable exceptions. Chinese equities in particular have been on the back foot all year after a regulatory crackdown on various industries, including education and tech.
Two new Chinese entrants on the 5-star list this month are high profile ones. Tech giants Alibaba (BABA) and Tencent (00700), both have wide economic moats but have dropped into 5-star territory after recent share price falls. At around $173 per share, New York-listed Alibaba is trading significantly below its fair value of $302. Morningstar’s Chelsey Tam acknowledges that the company has been under pressure this year, but is well positioned to leverage its user base of internet users and online shoppers into other areas. “We think a strong network effect allows leading e-commerce players to extend into other growth avenues, and nowhere is that more evident than Alibaba,” she says.
Wide Moat, 5 Star
There are 60 companies worldwide on our 5-star list and Alibaba and Tencent are among the five to also have wide economic moats. These companies have the dual advantage of being signidicantly undervalued but with strong competitive advtanges. The other three are brewer Anheuser-Busch (ABI) and UK-listed tobacco firms Imperial Brands (IMB) and British American Tobacco (BATS). In contrast, the majority of the 5-star firms under Morningstar coverage have no economic moat, while 22 have a narrow economic moat.
As in August, Technip (FTI) is the most undervalued of all the stocks under Morningstar coverage. The company, which is listed in New York and Paris and provides engineering and construction services for the oil and gas industry, remains the most undervalued company with a price/fair value of 0.27. That means there is a potential upside of 73% to the shares, which are currenty trading at around $6 but have a fair value of $24. Morningstar analyst Preston Caldwell says that the current rebound in the oil industry is likely to help Technip in the medium term, particularly with exploration and production companies increasing spending in the coming years.
After China, the United States has the most companies in the list of most undervalued stocks. Discount website Groupon (GRPN) is among them after a share slump in August after revealing a loss-making second quarter. An investigation by the UK’s Competition and Markets Authority has not helped the shares either, as the consumer regulator found evidence that Groupon had not always passed on its discounts to customers.
In terms of European companies, France’s Renault (RNO) is the second most undervalued, according to Morningstar estimates. It’s joined on this list Japan’s Nissan (7201) and two companies are part of a wider Renault-Nissan-Mitsubishi alliance, which makes almost 8 million vehicles a year. Germany’s Volkswagen (VOW3) is another automotive firm to join the 5-star cohort this month. Other EU firms on the wider list include Just Eat Takeaway (JET), French telecoms firm Orange (ORA) and Italian aerospace company Leonardo (LDO).
How We Rate Stocks
Using the price/fair value ratio, investors can get an idea of where a company's share price stands in relation to its estinated fair price. For example, a P/FV ratio of 1 suggests a stock is perfectly fairly valued, whereas one with a ratio 0.50 is 50% undervalued.
Valuations change every day based on movements in the company’s share price, while Morningstar analysts also move their fair values up and down regularly, especially after financial results. As company prospects can change dramatically, particularly in dynamic emerging markets, our list of most undervalued stocks is likely to change on a daily and weekly basis.
Are these 5-star stocks a buy recommendation? Not necessarily. As the official methodology points out, the star rating is meant to be a “guidepost” and investors “must consider their own specific investment goals, risk tolerance, tax situation, time horizon, income needs, and complete investment portfolio, among other factors".
Our methodology for 5-star stocks is explained further below:
“We believe appreciation beyond a fair risk-adjusted return is highly likely over a multiyear time frame. Scenario analysis developed by our analysts indicates that the current market price represents an excessively pessimistic outlook, limiting downside risk and maximizing upside potential. This rating encourages investors to consider an overweight position in the security relative to the appropriate benchmark.”
