The Most Undervalued Asset

The most undervalued asset in today’s markets is visibility.

We are currently witnessing the mirror image of March 2009 in the markets: risk comes at a premium while visibility of earnings is cheap.
Remember? Back in the early months of 2009, markets were anticipating the end of the world as we knew it. Stocks were massively oversold. Especially those stocks that had any hint of cyclicality were to be avoided, whatever their valuation.

It all changed with a bang in March of that year. A newly sworn-in administration launched a massive fiscal stimulus package. Simultaneously, the Federal Reserve Bank upped the ante with an unprecedented monetary package. The stock market exploded and high beta stocks became the flavor of the day. They still are, on and off.

Since that turning point, traders have been focusing on “risk on/risk off” mood swings. The Fed announces it will print more money? Risk is on. The economy does not take off as forecast on CNBC and Bloomberg? Risk is off. As a result, all the action has been in those sectors with the highest leverage to economic activity.

That’s all well and good, but this game is getting a bit overplayed. I believe we are seeing the emergence of a new narrative.

Some investors are slowly – and finally – starting to wonder about how many aborted recoveries will be needed before the country decides to tackle its real problems. In the meantime, the majority of traders are still hanging on to their last successful trade: risk on, risk off. In spite of the recession in Europe, the hard landing in China and the everlasting black hole that is Japan, investors’ appetite is not abating. The US, somehow, will pull the world out of its misery by printing more money.

In the long run, though, great opportunities tend to emerge where people are not looking. It may be time to sit back and forget this binary market.

While running after potential big swings in cyclical earnings, market participants have neglected those companies that produce predictable earnings year after year. Yes, boring predictable earnings. I am not thinking here about high yielding stocks, which have had their moments in a world of vanishing interest income. Instead, the stocks that truly stand out today on a valuation basis are growth stocks which need their cash flow to continue their growth.

Here are a couple of the most striking examples. Teva, the world leader in generic drugs, is trading at 8 times earnings even though it has been growing its earnings year after year by more than 15%. Orpea, a European leader in nursing homes, has been growing at an annual rate of more than 25% for over a decade. I do not remember a time when Orpea’s stock was trading at less than a huge premium to the market. Today, Orpea’s multiple on next year’s earnings is down to 12, notwithstanding a pipeline of new businesses in line with its past record.

The question we are facing now is clear. Why pay low multiples for predictable earnings and good growth when you can pay high multiples for cyclical earnings at the top of the margin cycle?

Disclosures: The author holds positions in TEVA and ORP.PA

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