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The time to look for value in shares

May 10 2018 08:46
Schalk Louw

If there’s one flourishing industry in the Western Cape at the moment, it has to be the water tank supplying industry. 

It doesn’t matter which hardware store you go to, they’re all packed with water tanks and they can hardly keep up with the demand. 

This reminds me of a similar situation not too long ago. A short while ago, “load shedding” was one of the most feared phrases in South Africa and in the same way that the demand for water tanks are at an all-time high right now, the demand for generators was at an all-time high back then.

Of course, I myself got swept up in this euphoria and I eventually bought a completely overpriced generator. 

This story has a bittersweet ending. After purchasing my overpriced generator, there was only one more load shedding incident and to this day, I have used my generator only once. 

This same type of euphoria can often be seen in the stock market and although I’m not ready to call the current hype surrounding growth shares the next best thing, it’s hard to ignore its movement relative to value shares. 

Although there are no definitive definitions for either of the two, it’s widely accepted that growth shares represent high-quality shares that are expected to continue their earnings growth seen in previous years. 

That is why they usually trade at higher price earnings ratios (P/E) and price-to-book-value ratios. Value shares are seen as companies who have lost their popularity over the years, but due to the fact that they still have good and solid credentials, they are regarded as bargains. 

They usually trade at lower P/Es and price-to-book ratios.  

Graph 1: MSCI World Value Index relative to MSCI World Growth Index (source: PSG Wealth Old Oak & Thomson Reuters)

The best way to illustrate this phenomenon is to turn back the clock about 20 years. We were on the brink of the new millennium and with the internet having entered our lives, and terms such as Y2K that could have disrupted our lives electronically after the 31st of December 1999, growth shares such as those of IT companies soared.

We all know how that ended. 

Graph 1 above clearly shows us how investors have shifted their focus towards healthier companies that are trading at relatively lower prices since then. We also experienced one of the greatest corrections of all time 10 years ago, which was followed by a world recession that forced countless people to their knees. 

The solution, which attracted a lot of criticism, was the quantitative easing of interest rates in developed countries to levels very close to zero. 

This, combined with the major advances in technology, helped growth companies to grow a lot faster and suddenly terms like FAANG made its appearance in the press more and more. 

I definitely think there are more than enough published reports that point out the danger of investing in these shares right now, so I would like to focus on identifying international companies that may possibly benefit from the current movement back towards value shares. 

The four companies listed below are not only priced “cheaper” according to valuations, but they are also still considered as fundamentally healthy companies. 

Deutsche Telekom AG (DTE GR)

Deutsche Telekom is one of the world’s leading providers of telecommunications and information technology with operations in Germany, USA and Europe.

Upon completion of a recent deal regarding a possible merge between T-Mobile US and Sprint Corp. 

DT will become the largest shareholder in the new entity and control 69% of the voting rights.

This new entity will be the most powerful mobile communications company in the US. DT is currently trading at a P/E of 19.74, forward P/E of 13.45, price-to-book ratio of 2.67 and dividend yield of 4.47%.

Lloyds Banking Group Plc (LLOY LN)

Lloyds Banking Group is a leading UK based financial services group providing a wide range of banking and financial services, focused on personal and commercial customers.

They’re trading at a P/E of 14.82, price-to-book ratio of 1.19 and dividend yield of 4.74%. 

For the first quarter of 2018 they delivered a strong financial performance with increased profits, returns and capital, therefore providing more protection for credit and upside for equity. 

Given a forward P/E of 8.14 and the quality of their financial statements, this stock can be seen as a good value pick.

Samsung Electronics Co Ltd (005930 KS)

Samsung is a Korean-based company principally engaged in the manufacture and distribution of electronic products.

Their three major segments are consumer electronics, IT and mobile communications and device solutions. 

They recently released their results for the first quarter of 2018 in which their sales increased by 20%, with Semiconductor sales showing the biggest increase and now contributing 34% to total sales; operating profit for the group increased by 58%.

Management expects stronger profit generation in the second half of 2018, mostly driven by the parts business forming part of the device solutions segment. 

Samsung is relatively cheap, trading at a P/E and forward P/E of 8.84 and 7.13 respectively, and dividend yield of 2.01%. Their current price-to-book multiple is at 1.97.

Total SA (TOT)

Total is the world’s fourth-largest oil and gas company, as well as a major integrated player in low-carbon energies. TOT recently released a strong set of results for the first quarter of 2018. Oil prices continued to rebound, supported by strong demand leading to an increase in their adjusted net income by 13% while their production also increased by 5%.

Management raised their guidance of production growth to over 6% thanks to the start-ups and ramp-ups of new projects and integration of recently acquired assets. 

They are currently trading at a P/E of 19.61, forward P/E of 11.79, price-to-book ratio of 1.69 and a dividend yield of 4.88%.

Schalk Louw is a portfolio manager at PSG Wealth

investment  |  portfolio  |  shares
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