Top fund managers’ favorite value stocks

We’ve unearthed the 25 favorite value plays of the world’s top fund managers. Oil, energy and banks are big themes.

A common problem that investors face when selecting the market for value stocks is that, rather than unearthing underappreciated opportunities, the primary conclusion may be investment dross. Indeed, low valuations are often the hallmark of value traps – stocks that look cheap on the surface, but only because they offer exposure to a company in terminal decline.

But what if the starting point for the hunt for value were stocks already endorsed by the world’s top fund managers? Does it help sort the wheat from the chaff?

We give it a whirl. The question of whether companies fix the future has been left aside for this exercise.

Here’s how we put our screen together, followed by the results.

STEP 1: The hunting ground

Citywire’s unique Fix the Future database contains details of some 7,000 stocks held by the world’s top fund managers, or roughly the top 5%. However, not all of the holdings of these elite investors should be considered equal.

Managers are placing much larger bets on their preferred stocks. And when managers really put their necks on the line by being overweight, they’ve probably spent a lot of resources checking they’re not betting on a dud.

The researchers found evidence that the funds’ most overweight positions tend to outperform other holdings convincingly.

We have developed a rating system that allows us to assess the collective conviction of all the elite managers we follow for each stock in our database. To try to minimize our chances of running into value traps when picking value, we’ve used our conviction rankings to focus our search for cheap stocks on the tenth most popular stock in our database. .

STEP 2: The hunt

Stock valuations tend to reflect the investment merits of the company that issued the stock. While high valuations are generally associated with companies with attractive characteristics, such as high growth and high profitability, low valuations generally reflect a struggling company.

However, when the outlook is very difficult for a company or industry, investors tend to become too negative. This is when opportunities can arise from valuations that are too low.

Although the classic value investing approach of buying cheap commodities hasn’t worked very well over the past 15 years, it’s still one of the best and oldest investment ideas around. . It was originally popularized by Benjamin “father of value investing” Graham in the 1930s and was given statistical influence in the 1990s by Eugene Fama and Kenneth French – two rock stars from finance academia , if that’s not too much of an oxymoron.

Value fans have several reasons to hope that rising interest will boost the fortunes of this recently maligned investment approach – these reasons range from rising “discount rates” reducing the value of earnings growth to the revitalization of the capital cycle as so-called “zombie societies”. go below.

Our hunt is based on simply finding the cheapest stocks among the tenth favorite stocks held by the best funds in the world. This is a rather purist approach to ‘value’, but by focusing only on elite stocks, the hope is that it doesn’t turn out to be as naïve as it otherwise would be.

What we reviewed

We’ve taken what’s called a “composite value” approach to our display. This assesses how cheap stocks look across a range of valuation measures. The measures we used are:

  • Price/Earnings (PE) ratio forecast for the next 12 months (+12 months)
  • Forecast +12 months of dividend yield
  • Historical shareholder return – a return based on dividend per share plus net redemptions per share
  • Expected Enterprise Value (EV) + 12 months of sales
  • EV-to-forecast +12 months earnings before interest and tax (Ebit)
  • Forecast of +12 months of free cash flow (FCF) return
  • Forecast of a price-to-book (P/BV) ratio of +12 months – a valuation measure which, although largely avoided, is still very useful for financials and some other asset-centric sectors
  • Forecast +12 months PE growth ratio (PEG)

We require stocks to have a rating based on at least three of our valuation metrics to qualify for the screen.

STEP 3: Transportation

Some notable themes emerge from the 25 cheapest elite stocks. On the one hand, 25s are certainly cheap, suggesting that elite managers have no problem playing the value game.

The average expected PE of the 25 is only 6.3 while the average dividend yield stands at 5%. The yield of FCF is on average 16% and the average PEG is only 0.65.

The cheapest of the cheap

Here’s a look at which stocks look the cheapest on each of the valuation metrics we’ve assessed based on FactSet data:

  • PDC Energy (US:PDCE) claims the cheapest stock title based on both its predicted PE of just 3.6 and its gargantuan predicted FCF yield of 23.5%.
  • The highest expected dividend yield belongs to glencore (GB:GLEN) at a rate of 9.9% which is surely not sustainable. The company also has the weakest EV sales vs. forecast of 0.39 times.
  • Highest All-Time Shareholder Return Award Goes to Dallas-Based Building Materials Distributor FirstSource Builders (US:BLDR) at an incredible 27%.
  • Norwegian oil company Equine (NO: EQNR) is the cheapest stock based on EV-to-forecast Ebit, valued at a measly 1.8x.
  • UK electricity and wood pellet distributor Drax (GB:DRX) is the cheapest stock based on its PEG which comes in at a tiny 0.03 times.
  • Finally, the cheapest stock relative to book value is UK Bank Barclays (GB:BARC) rated at just under 0.5 times.

The first sector theme to stand out from our list is the dominance of oil and energy companies. And there is a mix of “brown” and “green” pieces. Some focus on renewables, such as British power producer Drax (although there are skeptics of the virtues of the wood pellets it burns as green fuel), while others are at the foot of their transition from less climate-friendly businesses, such as Shell and Total Energies.

Most of these companies are currently making windfall profits thanks to incredibly high selling prices caused by events related to the Russian invasion of Ukraine and the restarting of the global economy after the Covid shutdowns.

However, as the risks of recession increase, in part due to rising energy prices, the circumstances that these companies have recently benefited from could also sow the seeds of the downfall. Already, the price of oil, which some had predicted to hit $200 a barrel, has fallen below pre-war levels in Ukraine. After peaking at over $120 a barrel, WTI Brent Crude is now trading below $90.

The activities of these companies are also increasingly politicized, ranging from talks of windfall taxes to calls for more action on climate change.

Thus, the low valuations of these companies reflect expectations that the good times for earnings experienced in 2022 will not last.

Financial companies, and in particular banks, are another prominent theme.

While the recent wave of interest rate hikes by central banks to counter inflation should benefit bank profitability, a recession induced by the cost of living could lead to higher provisions and write-downs related to receivables questionable.

Chinese banks have a remarkable presence in the list of cheap stocks. These institutions face the added worry of a housing market meltdown, which could have profound and systemic consequences for the sector.

Cyclical companies are also very present. With a recession looming, a number could face falling demand and declining pricing power as costs soar.

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