Analysis: Stock picking back in vogue as equity herd scatters

By Dominic Lau

LONDON (BestGrowthStock) – Equity investors will have to dig deeper to unearth stock winners instead of taking a broad-brush view by just picking sectors as the global economic recovery slows and the corporate earnings cycle matures.

The credit crisis in 2007 and 2008 was like a pistol shot that sent equity investors stampeding for cover in defensive sectors like pharmaceuticals, food producers and telecoms.

The big-picture macroeconomic environment was all-consuming and no one wanted to get trampled under foot.

Likewise, as the economy climbed out of its pits in early 2009, investors wheeled around to bet furiously on battered cyclical stocks such as banks, miners and automakers.

For instance, European banks rose more than 48 percent last year versus a 26 percent gain for the benchmark STOXX Europe 600.

As that roaring recovery reverts to a gentler canter and valuation metrics turn ambiguous on any sectoral winners, investors have to do their homework again and find companies that offer long-term growth in an uncertain environment.

European banks and basic resources carried one-year forward price-to-earnings (P/E) ratios of 9.09 and 10.97 respectively, Thomson Reuters DataStream showed. That compared with 9.64 for the healthcare sector, 9.68 for telecoms and 10.71 for the STOXX Europe 600.

In terms of performance, the healthcare index is down 0.6 percent so far this year, while the other three sectors are down 3.5 to 7 percent.

“You have got to dig deep,” said Mark Bon, fund manager at Canada Life in London.

“You have got to not just go for the big companies, you have got to go for niche companies that have targeted products with not so much competition whereas profitability is very strong and sales growth is still very strong.”

Bon favored hearing aid maker Sonova and Essilor, which makes lenses for glasses, as plays on the aging population in the West. He also liked Novo Nordisk, which is going to benefit from higher sales of diabetes insulin in the emerging markets.

“The traditional defensives — the utilities, the telecoms, the healthcare — have all got longer-term issues which undermine the growth models … pricing, competition,” he said. “One alternative that people are looking at is specific industries that have been doing quite well.”

Illustrating the difficulties in picking winning sectors, utilities, which carried a one-year forward P/E of 9.88 versus a 10-year average of 13.93, were the worst performers in Europe.

However, the sector offered a dividend yield of 5.16 percent, DataStream showed, the second-highest after telecoms and compared with yields of 3.364 percent on 10-year gilts and 2.655 percent on 10-year Bunds.

The oil and gas sector had the third-highest dividend yield of 4.7 percent and a one-year forward P/E of 8.55, though BP’s

Gulf of Mexico spill and the global growth outlook did not make a convincing case for the sector.

DO YOUR HOMEWORK

“The market in the next few years could resemble the environment we saw in the early 1990s … where you didn’t need to take a view on the market,” said Philip Lawlor, investment strategist at Smith & Williamson.

“What you want is a company that’s not going to disappoint. It’s not going to shoot the light out … It can drive volumes, it has got some pricing.”

Goldman Sachs highlighted drugmaker Novartis, construction group Vinci, inspection services company SGS and luxury goods maker Hermes among the companies that will provide stable growth.

Another indication that it pays to be a stock picker is companies are showing divergent earnings after rebounding from their troughs around mid-2009.

“As the earnings cycle begins to mature, you are seeing already now you have bigger differences between winner and loser stocks. Stock picking in the next couple of years is going to be more important,” said Michael O’Sullivan, head of global asset allocation for Credit Suisse’s private bank.

However, Alec Letchfield, chief investment officer at HSBC Global Asset Management’s private client arm, said many investors would likely use both a helicopter view of the economy as well as stock screening to enhance their returns.

“I suspect in reality it’s going to be a combination of the two, a bit of macro and stock picking backdrop,” he said, adding he favored quality cyclical stocks like Whitbread, Britain’s biggest hotel operator, and caterer Compass.

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(Editing by Michael Shields)

Analysis: Stock picking back in vogue as equity herd scatters