Digging for value in a two-faced market

"There is a strong school of thought and much commentary in the financial press that global investment sentiment is currently bullish and stock markets are expensive. We would contend that it is difficult to make this assertion categorically and especially when one looks at the very attractive valuations in the unloved parts of the market. However, it is clear to us that some stocks have become extremely expensive and we anticipate very poor medium term returns for investors that are chasing the darlings of the market. Domestic retail stocks provide very good examples of how much the stock market is currently prepared to pay up for earnings visibility and growth over the immediate future. Given the massive discrepancy in sentiment and valuations for different stocks, we continue to caution investors against making an assessment as to whether the stock market is over or under-valued at an index level.


Examples of very unloved and hence contrarian investment opportunities include global financials and raw material shares. We remain of the view that carefully selected resource stocks currently provide a very good opportunity on a risk-return basis for patient investors with a long investment horizon.
We have high conviction in the likes of Anglo, Sasol and Billiton at these share prices.

Within Resources, our process sees us favouring the higher quality cash-generators. We focus carefully on strength and track record of management. As we do not attempt to forecast commodity prices we strongly prefer low cost producers with high quality assets which trade at a healthy discount to what we think those assets are worth.

Anglo’s share price had declined by 30% since February of last year. Commodity prices have fallen sharply, from elevated levels, over the past twelve months and as a result consensus earnings forecasts for 2012 through 2014 for Anglo have been cut. The decline in commodity prices can largely be attributed to a slowing Chinese economy as well as general fear over global growth amidst the European crisis. It is these fears that present the opportunity to acquire quality resource stocks, like Anglo, Billiton and Sasol, at very attractive prices.

As the chart below shows, the Resource Index has been a material under-performer of the ALSI since the end of 2001, and once again in recent months."

"The PSG Angle is an electronic newsletter of PSG Asset Management.