Hofflin: There’s a long list of worries. Finding cheap stocks isn’t one of them

Inflation is the thread tying together almost every headline weighing on markets right now. Whether it’s high oil prices, rate hikes or falling house prices, Dr Philipp Hofflin, Portfolio Manager/Analyst at Lazard Asset Management, says inflation is sitting at the heart of everything.

“There are always things to worry about. But having done this for a fair few years now, there are much more worrying signals and dynamics out there than there have been in the past in a really fundamental sense,” Hofflin says.

While Hofflin says headline Brent crude isn't especially elevated by historical standards, falling global inventories and squeezed refining capacity, partly a byproduct of Ukrainian strikes on Russian refineries, have pushed the "crack spread" to the point where, at times, it has cost more to refine a barrel of oil than the barrel itself cost to buy.

Then there is the “elephant in the room”: the fiscal position of governments across the West.

“To put the numbers to this, they raised $4.5 trillion and they spend $6.3 trillion. It's almost a $2 trillion gap. Almost the size of the Australian economy is their deficit. Put another way, for every dollar the US raises in taxes or tariffs or whatever, they spend $1.40.”

In this episode of The Rules of Investing, Hofflin explains how increasing volatility and reduced liquidity are creating opportunities, takes a look back at the “fallen angel” stocks he bought a year ago, and picks another beaten up stock that’s great value.

Value in the chaos

For a value investor, though, none of this is purely bad news. Hofflin points to a genuine structural shift in how the market's biggest stocks now trade that's creating exactly the kind of mispricing his strategy is designed to exploit. It’s paying off as well - the Lazard Select Australian Equity Fund has returned 15% over the last year.

The volatility around reporting seasons is far more than merely anecdotal, he adds, pointing to a sharp rise in the number of ASX 100 stocks moving more than 10% on results day - including 12 in the recent August period.

“Once upon a time, there used to be years when this didn't happen at all for these large caps. Even in February 2009, when the GFC disasters were revealed, there were five companies.”

He adds that there are two forces driving it. First, liquidity in Australia's largest stocks, the ASX 20, has roughly halved compared with historical norms, largely a function of the passive investing boom.

“These stocks have very big index weights and these are passive holders. By definition, passive means there's very little trading. That's the attraction of being passive. But it means liquidity has fallen, therefore any volatility becomes greater because there's less depth in the market,” Hofflin notes.

Second, the composition of who's actually trading has shifted. In the US, Hofflin says only 10-15% of trading now comes from fundamental investors, with the rest split between quant funds, high-frequency traders and short-term retail activity.

“They buy stocks for the next day or week or month. We buy stocks because we want to hold the stock for three or five years or forever. Very different horizon. All this shorter motivation means the short-term moves are greater.”

Cochlear (ASX: COH) is his favourite recent example. The stock fell 32% in a single day in April and 45% for the week, which Hofflin says he hasn't seen from a large-cap stock in years. Lazard didn't previously own it but it became completely differently priced and they bought in. The stock has since rallied 50%.

“One of those examples where if the market were not more volatile, we wouldn't have got the chance. I’m all in favour of less efficient markets, because it gives us opportunities.”

Revisiting the fallen angels

It's the same dynamic Hofflin described the last time he sat down with Livewire, picking an eclectic mix of fallen angels: former market darlings that had derated sharply, largely on multiple compression rather than genuine earnings collapse:

• CSL Limited (ASX: CSL)
• Sonic Healthcare (ASX: SHL)
• Ramsay Health Care (ASX: RHC)
• James Hardie Industries (ASX: JHX)
• Reece Limited (ASX: REH)
• Mainfreight Limited (NZSE: MFT)
• Woolworths Group (ASX: WOW)
• Domino’s Pizza Enterprises (ASX: DMP)
• IDP Education (ASX: IEL)

So how has that basket performed?

“It seems extraordinary, but I think it was justified in the sense that the stock was just so underpriced.”

Elsewhere, the results have been mixed, which Hofflin treats as simply part of the process. Woolworths bounced hard and has already been sold, Domino's remains a slower recovery story, still held but well off its lows. Lazard finally took a small position in James Hardie and made money on Reliance (ASX: RWC) before it received a takeover bid, but has stayed away from Reece, judging the US market too troubled.

Lazard also missed Ramsay Health Care entirely after being “too conservative”, and remain wary of ResMed given emerging Chinese competition in sleep apnoea devices.

“The really pleasing thing is we had a really good year, but when you do a good attribution of all our fallen angels, it’s actually quite positive over that period,” Hofflin says.

“It's a nice surprise because very often as a value investor, when you go into something, you do it because it's very unpopular and it's against the trend and often takes a bit of time for the market to realise what you're seeing. But in this case, it's already started paying off.”

The next beaten up stock: IDP Education

If there's one name that best captures Hofflin's contrarian instincts today, it's IDP Education (ASX: IEL). IEL places international students with universities, and government crackdowns on student visa numbers across the UK, Canada and Australia have been brutal for the sector.

“We bought this last year and we thought we bought really well when we did, but it's fallen quite a bit further.”

The stock has fallen 96% from its 2021 high of $40 to around $1.50 but Hofflin is emphatic that the vast majority of that collapse, 87 percentage points of it, came purely from multiple compression rather than a collapse in the underlying business.

“The top line's been terrible, but the point is it's actually a good business. I say this because they're the top end. They don't do the dodgy language colleges, they do G8 universities,” he says.

“The FY26 result was terrible, but the ROE was above market average. It’s asset light, good returns, good balance sheet.”

The company is also buying back 10% of its share register at current prices. Once trading at 50 times earnings during the post-Covid student boom, it now sits on less than seven times.

“Is the bottom and do governments eventually say, ‘I need to fund my university systems, I don't have the money, let's let in some good quality students at the top?’ We don't know, but the asymmetry in the outlook here is great. So I think it is worth owning some.”

Watch the interview below for the full experience.