Global equity markets are slowing down their pace after the extraordinary post-pandemic outbreak rally. The Morningstar Europe Index NR performed modestly in the third quarter of 2021 (1.4%), after gaining 15.4% in the first half of the year.
Nevertheless, Morningstar analysts believe equities in developed Europe are still slightly undervalued today: the median stock in our European coverage universe trades at a 1% discount to our current fair value estimate. Currently, 90 components out of the 1,612 that we count in the Morningstar Europe Index portfolio have a Morningstar Stock Rating of 4 or 5 stars.
In aggregate, as observed by our latest European Market Barometer, energy, financial services and real estate stocks look undervalued, meanwhile the technology and consumer cyclical sectors are the most overvalued. After recent strong gains, however, the energy sector saw its Price/Fair Value ratio - Morningstar's measure of market valuation - rise from 0.81 in August to 0.92 at the end of September.
Here we look at some undervalued stocks across sectors that are among our analysts’ best ideas.
Communication Services
The communications-services sector underperformed the broader European market for the year-to-date, as measured by the difference between the Morningstar Developed Markets Europe Communication Services Index (up by 7%) and the Morningstar Europe Index (+17.8%; data in Euros as of Oct. 8). According to Morningstar’s research, the median sector’s stock is now trading at a 6% discount to its fair value estimate.
Consumer Cyclical
Stocks in this sector have had a poor last year and are now trading at a 4% discount to their fair value estimate in our European coverage universe. Investors can find opportunities in the car industry in particular, but not exclusively.
“We expect consumers to begin to spend excess savings on experiences, including travel” estimates Erin Lash, director of consumer sector equity research for Morningstar. In fact, the industry has been showing signs of a rebound. “We believe consumer demand for leisure travel will be enough to continue this upward momentum and push travel bookings equal to pre-pandemic levels by early 2023,” she concludes.
Consumer Defensive
Overall, the sector seems overvalued, with the median stock in our coverage universe trading at 2% above our fair value estimate. However, there are several 4- and 5-star names.
Supply chain constraints continue to provide headwinds. Further, as COVID-19 cases surged, consumers resorted again to e-commerce. “Retailers that differentiate their experiences and offer convenient omnichannel options stand to retain the shoppers they've gained since the pandemic began,” says Lash.
Energy
Although energy stocks have benefited from the strong rebound in commodities in recent months, the sector remains undervalued by our metrics, currently trading at a 12% discount to fair value, with the largest deviations in services and exploration and production activities.
“We expect the recovery in consumption to persist”, affirms Dave Meats, director of research, energy and utilities, for Morningstar. “Vehicle miles traveled has largely recovered, along with consumption of petroleum products like gasoline and diesel. Nevertheless, we think oil prices are frothy, and stand by our $55/bbl midcycle forecast for West Texas Intermediate crude”, he explains.
Financial Services
Financial stocks rebounded in the third quarter and have outperformed the market since the beginning of the year. Overall, the financial sector is now trading at an 11% discount to the fair value estimate. “Most of the primary drivers of earnings for financial sector stocks have continued to trend positively,” highlights Michael Wong, director of equity research, financial services, for Morningstar.
Healthcare
Overall, European healthcare industry stocks are broadly in line with Morningstar analysts’ valuation (currently at a 1% discount). Since the beginning of the year, they have underperformed the market by around 7 points.
Morningstar analysts think the industry fundamentals are strong, based on continued innovation, and expect growth to accelerate in several more elective healthcare areas for the remainder of 2021.
Industrials
After outperforming the market over the past year (the Morningstar Developed Markets Europe Industrial Index gained 28.6%), European industrial stocks are overvalued by 6 percentage points according to Morningstar research. However, there are still some undervalued names.
Technology
With a year-to-date performance of 18.8%, the tech sector continues its run. It is currently overvalued by 14%, yet there are still companies with attractive valuations, especially in areas such as cloud computing, 5G and the “internet of things”.
Utilities
The sector underperformed in 2020 and continued to do so in 2021. The industry is currently trading at an 8% discount, according to Morningstar research.
“We don't see any immediate signs that utilities' performance will improve markedly during the next few quarters,” says Travis Miller, energy and utilities strategist for Morningstar. “Inflation remains a near-term obstacle, as some utilities adjust their spending plans. That being said, utilities remain one of the few places in the market where investors can find stable, growing income,” adds Miller.
