Tag Archives: pro
Asset Values And Valuation
What’s a stock worth? “The market is overvalued.” “No, it’s fair.” “No, you’re missing the point – the economy has changed.” “What? Are saying it’s different this time?” “It’s always different.” Arguments over stock-market valuation have been around ever since stocks have traded. In many ways, the purpose of an open stock market is to discover what the clearing price for a company should be – what price satisfies both the buyers and sellers of a company’s shares. But just knowing something’s price doesn’t tell you what it’s worth. As Warren Buffett is fond of saying , “price is what you pay, value is what you get.” There are two general ways to value an asset: bottom-up, fundamental analysis that focusses on the present value of expected cash flows; and top-down, relative-value analysis that looks at the entire market and the range of investment alternatives. The first examines a specific company; the second evaluates an entire industry – or even the whole economy. Any economic asset generates cash over time. This cash flow can be forecasted, and the results discounted to present value. With bonds, this is fairly straightforward; the cash-flow is contractual. With stocks earnings can be more volatile, but they can also grow over time. We compensate for this by increasing the discount rate. Lower risk means a lower interest rate. Net present value formula. Source: Wikipedia The top-down approach looks at any asset and asks, “Compared to what?” So we use various financial ratios – price/earnings, price-to-book, enterprise value over free cash flow. With bonds, we focus on the “spread” – their level of yield above comparable risk-free government bonds. By checking what else is out there – playing the field – investors can see how what they own looks relative to everything else. Map of S&P 500 PE ratios. Source: Financial Visualization Both methods have their merits: bottom-up analysis generates an intrinsic value – something that is fairly stable over time. Top-down valuation looks at the range of investment alternatives. No investment, after all, is an island. But folks who only focus on bottom-up analysis can get distracted by the details and miss the forest for the trees. Top-down studies can be too volatile: the world may always be changing, but it doesn’t change that much from day to day. And human nature never really changes. Financial analysis tries to answer the question of what an asset is really worth. It’s a good question. In the end, though, a stock is only worth what someone else is willing to pay for it.
Equity Investing In A Low-Growth World
Global investors are figuring out how to cope with subdued growth. We believe the key is to focus on companies with strategic advantages in industries that can thrive – even in a low-growth world. Growth is clearly getting harder to find. Earnings reports for the third quarter showed diverse companies, including IBM (NYSE: IBM ) and Nestlé ( OTCPK:NSRGY ), falling short of expectations. China’s slowdown has spooked markets and fueled concerns that the world’s second-largest economy may not pull its weight in the coming years. And in the U.S., the Federal Reserve is reluctant to push up interest rates, fearing that the domestic economic recovery is still too fragile to withstand pressures emanating from abroad. Sluggish Days Ahead These are just some of the factors restraining growth around the world. Consensus estimates indicate that the global economy will expand by 2.9% in 2016. It’s not quite a recession or a crisis. But it’s far below the annualized rate of growth averaging about 4%-5% over the last decade. So what should equity investors do in this environment? We think there are three solid strategies for investing in a low-growth world: Invest in high-quality companies that are genuine growth businesses Search for undervalued companies that can restructure themselves to unlock value Look for companies with strong dividend yields Surprising Sources of Rapid Growth Let’s focus on the first category. The good news is that if you look in the right places, you can find surprising sources of healthy growth. Start by zeroing in on industries or trends poised to drive continued rapid growth, such as: The Internet of Things – As the number of connected devices continues to expand exponentially, companies that can provide enabling technologies should continue to grow at a rapid clip no matter what is happening in the surrounding economy. Payment Systems – The way we pay for goods and services is continuing to evolve. Payments technology is growing at a rate of 16% a year, according to A.T. Kearney, with payments using mobile technology are just beginning to take root. This is creating growth opportunities both for new companies that enable innovative payment services as well as incumbent payment processors and credit card groups. Healthcare – Aging populations in the developed world should create demand for targeted medicines. As science unlocks the secrets of the human genome, sophisticated treatments that are designed for individual needs are expected to play an increasing role in the pharmaceutical markets. Savings in the Developing World – In many emerging-market countries, the penetration of financial services is extremely low. As these societies become wealthier and more educated, greater financial awareness is likely to spur demand for more sophisticated products. Financial services firms that can tap into these needs-and are skilled at marketing in diverse cultures-are expected to grow faster than peers, in our view. Looking for Exceptional Companies These are just a few examples of pockets of growth that are expected to persist, even in a low-growth world. In passive portfolios, investors will by definition be holding positions in many low-growth companies that are vulnerable to domestic and global economic troubles. Active managers with skill should focus on building portfolios with companies that have strategic advantages in areas like these and can benefit from diverse return drivers throughout economic cycles. Challenges to growth will continue to cloud the outlook for equity markets for a while. But by identifying trends that can defy the sluggish environment-and the exceptional companies in these areas-we believe investors can tap into real sources of growth that can withstand the test of time. The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. AllianceBernstein Limited is authorized and regulated by the Financial Conduct Authority in the United Kingdom. Mark Phelps, Chief Investment Officer – Concentrated Global Growth