Volatile markets make for an interesting sort of litmus test of investor mettle. It’s easy to parrot quotes like the late Sir John Templeton’s famous line, “To buy when others are despondently selling and to sell when others are buying requires the greatest fortitude and pays the greatest ultimate rewards.” But he didn’t just talk that talk, he walked that walk.
Sir John’s contrarian conviction was so strong, that in 1939 when WWII had investors fleeing the markets, he bought every stock on the New York Stock Exchange trading under a dollar. Cindy Sweeting, Director of Portfolio Management at Templeton Global Equity Group, espouses Sir John’s contrarian approach, although as a more selective bottom-up stock-picker today. As the markets have bumped along recently she has also echoed his money-where-your-mouth-is action, avoiding the same trend plays everyone else is making by the doing the far more difficult work of going against the grain.
“We believe that a value discipline is an anchor in a very uncertain and volatile market. Most investors try to go where things look optimistic or in the direction they believe the rest of the crowd is heading. But really, the only way to get a bargain is essentially to buy what most investors are selling. We’re very much in the contrarian mode of buying pessimism.”
However, the trick of unlocking long-term value goes beyond simply being contrarian. As Sir John Templeton also said:
“The best bargains are not just stocks or assets whose prices are down the most, but rather those stocks having the lowest prices in relation to future potential earnings power.”
It’s all about taking a forward-looking approach to value, Sweeting explains.
“Uncovering value takes a differentiated perspective driven by fundamental analysis and study – and, importantly, taking a differentiated time horizon from a predominantly short-term crowd. Through fundamental research and analysis, we seek stocks where the longer-term earning power and the cash-flow generating capability of a company appear mispriced or underpriced by the market.”
That long-term perspective is a key part of the Templeton approach, focusing on what could change not only tomorrow or next week or next year, but over the next five years. In this age of instant gratification, that can take a hefty dose of resolve.
“We are patient stock pickers. We recognize that prices tend to fluctuate much more than underlying value. And that creates opportunities for investors who have the fortitude to look a bit further down the road and take advantage of the market’s emotional rollercoaster. Our approach is to be objective and non-emotional; to have patience and fortitude; to buy pessimism and sell optimism where the fundamentals support our conclusions.”
Opportunity in Pessimism
The financial sector offers an example of where pessimism has reigned for some years in a number of markets, particularly in Europe. A historical analysis would show the US to be a fertile hunting ground for cheap financials, but by comparison, European banks have been even cheaper, with a 35% to 45% discount on a pricing basis1.
“In the last few years, we’ve started to uncover bargains in financials as pessimism reigned, particularly in Europe. Our research focuses on a forward-looking view to determine if the near-term issues are transient, are fixable and will show potential recovery. And we believe that many cheap financial franchises that came onto our radar screen in the aftermath of the [2008 – 2009] financial crisis will likely show recovery, as their issues appear transient.”
Other areas where Sweeting has found bargains lurking are in the energy and oil service sectors, which have seen some difficult years recently.
“We think the market has been worrying excessively about economic growth prospects, and oil and energy demand in general. We’re pretty excited from a structural point of view that oil service companies are going to be the beneficiary of increased capital expenditures from integrated and state-owned oil companies, and the increasingly more expensive search for reserve replacement. We see a very good opportunity for potential future earnings at very low prices.”
The overvalued technology sector of the 90s “dot.com” days stands as an example of an expensive sector surrounded by lots of optimism that has taken years to come back to earth.
“Today, many companies within technology are trading at a significant discount to their long-term earnings and cash-flow generation potential. Valuations are low in our view, free cash-flow is high, return on invested capital is high in many cases, and we find managements are returning cash-flow to shareholders in the form of dividends and buybacks. This is a stock-pickers’ market, and you can see how an area that has been labeled as ‘growth’ for many years can also offer value investors good opportunities, if you focus on fundamental research.”
On a regional basis, Europe presents an interesting opportunity for bargain hunting, when compared to the US and the emerging markets. Europe has been trading at big discounts to historical valuation levels because risk-averse investors have shunned the region for years.
“We believe Europe is a once-in-a-generation buying opportunity right now. Today, the price of European equities as a whole is at a 40-year low relative to US equities2. And we believe the current gap in earnings is likely to close over the coming months and years.”
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What Are the Risks?
All investments involve risk, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability, and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity. Current political uncertainty surrounding the European Union (EU) and its membership may increase market volatility. The financial instability of some countries in the EU, including Greece, Italy and Spain, together with the risk of that impacting other more stable countries may increase the economic risk of investing in companies in Europe.
1. Source: Credit Suisse Research, July 2013.
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