Two things matter for relative performance: what you own, and what you don’t. So what does that mean in the current environment?
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.
