After their worst year in decades, it’s time to buy so-called value stocks, argues this City expert.
Imperial Brands (LSE:IMB), SSE (LSE:SSE) and Legal & General (LSE:LGEN) also feature on the list, but Bank of America recommends investors avoid “value traps” Lloyds Banking Group (LSE:LLOY), BP (LSE:BP.) and Tesco (LSE:TSCO).
The 22 picks are based on the bank’s expectations for a potential 10% upside for value versus growth stocks by the first quarter of next year. It argues that the cyclical reasons for owning value have strengthened after the worst year for the investing style since 1992.
Its quant strategists’ screen of 250 of the largest stocks by market cap in the MSCI Europe index uses seven different valuation measures to identify the opportunity stocks with attractive yields as well as compelling fundamental drivers.
The value opportunities are dominated by stocks from the financial, consumer staples, industrials and communication services sectors. They include Vodafone, whose shares have continued to languish at 110p and just 12% above their March lows despite telco business models being regarded as substantially resilient to Covid-19 trends.
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We reported this month that analysts at Deutsche Bank think Voda shares should be trading at 230p, particularly in light of the company’s ability to continue paying a healthy dividend.
The encouraging trends reported in a recent update by Imperial Brands have also failed to inspire the company’s share price from the 1,300p level. Broker Jefferies said last week that it saw a strong case for a sizeable re-rating based on a price target of 2,139p.
Bank of America’s tilt towards value reflects factors including the ratio of earnings per share revisions being the strongest since 2018. In addition, 90% of fund managers expect a Covid-19 vaccine in place by the first half of next year, which should help lift bond yields.
The US 10-year bond yield has been a key determinant of value versus growth in the past 20 years, but hasn’t so far risen meaningfully in response to improving macro data. Two big European value sectors, banks and energy, have also continued to lag.
The note said: “We expect both obstacles to fade over the coming months, as we think a maturing economic recovery is set to translate into rising US bond yields and banks and energy are likely to outperform on the back of an improving earnings cycle. As a consequence, we expect value to outperform growth stocks by around 10% by early next year.”
The potential momentum for banks doesn’t extend to Lloyds Banking Group after it was named as one of the six value traps - stocks the bank thinks will continue to underperform.
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Widely held Lloyds is now worth less than £20 billion after shares fell to 27p on a combination of rising unemployment figures, Brexit uncertainty and the prospect of negative interest rates.
Tesco is another stock to avoid, according to Bank of America, as the supermarket’s valuation continues to disappoint despite the extensive transformation under former CEO Dave Lewis. Others shares on the list of value traps include Primark owner Associated British Foods (LSE:ABF).
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