Where’s the Bottom? | The Corona Correction | Refinitiv
Welcome to the Corona Correction series in association with Refinitiv. I'm your host, Roger Hirst. Over the last few weeks, we've spoken to analysts from a variety of sectors and asset classes to try and build up a picture of which areas are being badly hit, and which may be better coping with the impact of the virus. I wanted to pull back and take a top down view about the broader impacts and whether there was any value in the traditional sense appearing in the equity markets. Tim Gaumer is the Director of Fundamental Research at Refinitiv, and I asked him if there are any trends emerging. One thing we hear a lot of people asking themselves is 'where's the bottom'? 'What's already priced in'? Really tough to answer that first question, but we can help a bit with the second I think. We've developed a series of quantitative models and predictive analytics over the years that can look at things like growth rates that are priced in. So what's implied by the current price? We have an intrinsic valuation model. It gets a little technical. But, you know, for the CFA charter holders out there, think of a dividend discount model. Right. So typically you would put in some growth assumptions and solve for what fair value? What price does that growth rate in that string of earnings and dividends imply? We do that, but we also reverse engineer it. Right. So instead of just putting in our growth assumptions, which are really tough to come up with right now with any degree of confidence, do the opposite. Put it in the current price, assume the market's efficient. It's got it right. That today's price represents future growth rates, and then solve for the growth required to justify today's price. So you'll see it varies a lot by sector or industry. In some industries, market expectations are now very low. In others, it's still pretty high. But the key in all of this, if you're going make money as an investor, is to benchmark or read your expectations for growth compared to market expectations. But where do you go to read market expectations? And that's where our tool can help. So you can see that in some industries, the market is priced in negative compound growth rates, double digits for five years. You know, year after year, double digit declines. You know, maybe that's overdone. I'll include a word of warning here. Among that group there's probably a lot of not only great values, but value traps. You know, stocks that are cheap for good reason. And also, you know, encourage people to dig in, look at the balance sheet. You know, in good times, you look at profits and growth and opportunities and product launches. In today's environment, I'd turn first to the balance sheet. You know, will the companies, whether the storm. Is their dividend secure? You know, but beyond that, you know, you can look at some of the opposite, you know, companies where market implied growth is high. You know, there may be a few industries that benefit from this. You know, in logistics and online shopping and other things. But, you know, the warning there is, sometimes expectations can become too high. But at least now, you know, you have some tool to benchmark your expectations against what's already priced in. Tim highlights the difficulty in employing any methodology to a market that has been fundamentally broken. There are clearly some stocks and sectors in which current prices are implying negative growth out for a few years. Some of these distressed prices will be offering great opportunities, but there will also be value traps. Tim recommends looking at balance sheets. Whilst we have a little visibility on current cash flows, we can still see which companies had impaired their balance sheets prior to the Corona crisis and should therefore be avoided. Many of these will be in the Triple B segments of the corporate bond market. And a number of these companies are facing the prospect of being downgraded to junk. If you are going to dip your toe into the water, it's worth looking at defensive names first, such as utilities, with dull but relatively stable cash flows, and waiting for the dust to settle before taking on the racier end of the market. We'll see you later with another update.