The performance of major equity markets has created a uniquely challenging environment for value investors since the financial crisis. Europe has been no exception. As value stocks have de-rated, growth stocks have re-rated deepening the chasm between the two style factors.
On a variety of metrics, we can see the how stark the disparity has become. Looking at Bloomberg one year forward estimates, the average dividend yield for value stocks is approximately 5 per cent; meanwhile, growth stocks yield on average 2.5 per cent. In terms of valuations, consensus estimates of EBITDA (earnings before interest, taxation, depreciation and amortisation) are also revealing; with value stocks at less than 7x, while growth stocks average 11x enterprise value/EDBITDA.
Looking at performance since the financial crisis, the MSCI Europe Growth index has returned 156.56 per cent, while the MSCI Europe Value index has returned 96.6 per cent.
Source: EdenTree Investment Management
As data points reveal an increasing price disparity, the question is: will we see a gathering migration from growth to value?
There are a number of factors that explain the relentless rise of growth. Firstly, as growth-orientated companies have outperformed, growth strategies have dominated the market pushing up the premium on these stocks. Secondly, the consensus expectation of a relatively glacial rise in rates and the flattening of the yield curve have favoured growth stocks which have a higher duration than value stocks. Also suppressing cyclical value stocks has been a pessimistic market pricing in a return to recession when in reality, the global outlook remains robust.
A tale of two styles: Autoliv
The recent story of one stock illustrates the polarity between growth and value. The Swedish firm Autoliv recently split at the start of July 2018 to create two publicly-traded companies, one focused on safety equipment such as airbags (Autoliv) with value characteristics - and one focused on innovative electronics including radar products and advanced driverless assistance systems (Veoneer), which has a growth bias.
While Autoliv is a cash cow passive safety business, loss-making Veoneer has attracted huge flows from growth investors looking to play future automotive trends and the promise of rising earnings. Since the split, Veoneer has soared, returning 27.56 per cent, while Autoliv, a classic value stock, has plunged 55.13 per cent, despite it being an established global player benefiting from a diversified client base and high barriers to entry.
This wild disparity in fortunes underlines the current exuberance for growth versus the pessimism hanging over its value counterparts. We have since rotated away from Veoneer and built a position in Autoliv.
Source: EdenTree Investment Management
While it is impossible to predict the future, from both a relative and absolute perspective, there are a range of value plays with a focus on sustainability and environmental management that look increasingly attractive. These compelling opportunities lie across a spectrum of highly cash generative and high yielding sectors from utilities to underperforming telcos.
Future is Orange
Since the beginning of the year, telcos has been the worst performing sector and now looks attractive from both an absolute and relative perspective to the rest of the market. This unloved sector should experience strong growth in the demand for data both through increased consumption from retail customers and a strong growth in demand from the internet of things and machine to machine communication, translating into earnings growth.
Source: EdenTree Investment Management
On most valuation metrics, Orange trades at a discount to the wider telcos sector. It has a strong market position in the French and Spanish telecom markets where it has built out its own fibre offering allowing it to compete on equal terms with the incumbent operator, Telefonica. It is on a dividend yield of 5 per cent and forward price-earnings multiple of under 10x.
From our perspective as a responsible and sustainable investor, Orange is also a company with a long-term goal to promote a digital society where everyone can benefit from digital technology. The firm also has strong policies and practices on data protection privacy and a commitment to transparent reporting on climate impact and strong environmental management. We also like Deutsche Telecom, which is currently yielding over 5 per cent in a market that has converged from four major players to three.
Promoting environmental stewardship
Imerys, the French multinational which specialises in the production and processing of industrial minerals, has been indiscriminately sold off due to a weaker economic outlook. We like the firm’s focus on low-impact mining, innovative approach to sustainable material science and long-term strategy to support growth while promoting environmental stewardship. It has strong free cash flow generation, is on an 11x price-to-earnings and has a dividend of 3.4 per cent.
Meanwhile, the valuations of financials also looking interesting as rising rates will benefit this sector, particularly the banks, which have endured a steep sell-off. And while we remain underweight, we are increasing our relative position with holdings in Bank of Ireland and Société Générale.
It is hard to predict what the trigger will be for a sustained value rally. The disparity between growth and value may even get wider, but eventually, I believe the weight of fundamentals will precipitate a mean reversion, rewarding those investors who have rotated out of growth and are positioned in value stocks that look compelling from both from a relative and absolute perspective.
Chris Hiorns is portfolio manager of the EdenTree Amity European fund. The views expressed above are his own and should not be taken as investment advice.