Opportunities beneath the surface

Let’s start with how the world looks to an active stockpicker. An allocator might look at the headline: weighted by market capitalisation, world stockmarkets trade at 21 times earnings. A stockpicker instead sees 2,500 stocks to choose from, and the largest ones needn’t dominate. If we simply weigh companies equally, world markets trade at a more reasonable 15 times earnings.

There are differences, too, between regions. Through an equal-weighted lens, the cheaper half of stocks in the US trade at 13 times earnings. That is roughly the median of all shares elsewhere. Outside the US, the cheaper half of companies have a price-to-earnings ratio less than ten. Such value is plentiful, even with market indices near record highs. Of the 2,500 or so stocks globally, 500 can be bought for less than ten times earnings.

Speaking in those terms is convenient, but that isn’t how we, at Orbis, build portfolios. We aim to find businesses that trade at a substantial discount to their intrinsic value, and those discounts can take many forms: a stock suffering a spate of short-term setbacks, an industry priced as if a down cycle will last forever, a company trading for less than the value of its parts, or a quality business whose growth is underappreciated.

As we look at markets today, we can make two happy observations: some cheap companies aren’t junk and some great companies aren’t expensive.

In the first group are often-unexciting companies that have been so scorned that the market doubts their ability to ever create value for shareholders.

These include well-run holding companies like Jardine Matheson in Hong Kong. With subsidiaries offering exposure to consumers across Asia, Jardine has grown earnings and book value per share by 10% p.a. over the long term. Yet because part of its business is in China, Jardine’s shares have languished. It now trades for less than half its book value and at six times our estimates of earnings, with a dividend yield above 5%.

Korean financials offer similar attractions. Banks like KB Financial and Shinhan Financial earn decent returns on equity, yet trade at less than half their book value. Making money isn’t the problem—at current rates, they are earning over 20% of their market value every year. The problem is paying out more of it, though with dividend yields already above 5%, investors are compensated to wait.

High dividend yields are also a common sight in the UK across energy companies like Shell, utilities, construction firms, and consumer businesses. And in Japan, companies like Sumitomo Mitsui Financial Group are finally embracing commitments to grow dividends, giving hope that Japan Inc could at last improve its stance towards shareholders.

In the second group are companies which we believe offer better-than-average fundamental prospects, at valuations that do not reflect that potential.

Japan has its share, including game company Nintendo. The company owns some of the world’s most valuable intellectual property, but has historically been conservative in making money from it. The billion-dollar box office success of The Super Mario Bros. Movie has shown Nintendo that, in essence, it can get paid handsomely to advertise its games. Its next console should let players carry over their saved games, while using standardised parts that will make it easier for third-party studios to develop games for it. Trading at just above 20 times earnings, Nintendo’s valuation is near the average for world stockmarkets, but we believe its prospects are far better.

The US is home to many great companies, not all of which command front-page stories in the financial press. Managed care organisations like UnitedHealth and Elevance Health have consistently grown earnings more quickly than the S&P 500, while helping to make the US healthcare system more efficient. Yet today they trade at a discount to the S&P.

Payments companies Fleetcor Technologies and Global Payments have worked for years to better serve their small and mid-sized business customers, capturing opportunities as those firms grow and move from cash to digital transactions. We believe they can continue to grow earnings by well over 10% p.a., yet they trade at a steep discount to US and world market averages.

None of these companies are without risk. Jardine’s shares typically react to bad headlines about Hong Kong and China, US healthcare stocks can fluctuate with the election cycle, Korean banks live under sporadic threats from North Korea, Nintendo’s next console could flop, and no financial company is immune from economic cycles. Over the short term, valuation is among the worst predictors of returns, but over the long term, it is among the best.

The results of our bottom-up stockpicking makes us more relaxed about traditional categorisations. It is hard to say whether a fast-growing but discounted company is a growth stock or a value stock. It is easier to say that it should be rewarding for long-term investors to own.

Disclaimer

The contents of this communication have been approved for issue in the United Kingdom by Orbis Investments (U.K.) Limited which is authorised and regulated by the Financial Conduct Authority. Orbis Investments (U.K.) Limited and Orbis Investment Management Limited are members of the Orbis group of companies (“Orbis”).

This communication does not constitute an offer, solicitation or recommendation to buy, sell or hold any interests, shares or other securities in the companies mentioned in it. Orbis has not considered the suitability of this investment against your individual needs and risk tolerance. You must not rely upon this communication or any part of it as investment advice and Orbis does not assume and will not accept responsibility or liability (whether arising in contract, tort, negligence or otherwise) for any error, omission, loss or damage (whether direct, indirect, consequential or otherwise) in connection with the information in this communication and disclaims any such liability to the maximum extent permitted by law. This communication represents Orbis' view at the date stated and may provide reasoning or rationale on why we bought or sold a particular security for a fund. We may take a different/the opposite view/position from that stated. This is because our view may change as facts or circumstances change. This communication has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Entities and employees of Orbis are not subject to restrictions on dealing in relevant securities ahead of the dissemination of this review. Past performance is not a reliable indicator of future results. When investing your capital is at risk.