Hofflin: We’re buying the stocks you used to love

Markets are in full swing. The US market has doubled in three years and investors are acting like the good times will never end. But as Dr Philipp Hofflin, Portfolio Manager/Analyst at Lazard Asset Management, points out, the data paints a very different picture.

“The US market has doubled in three years. That’s not a normal rate of capital gain,” Hofflin says.

Across markets, the valuation gap between the most expensive and cheapest stocks is now the widest it’s been since the dotcom bubble. In Australia, the top 40 most expensive stocks trade at 56 times forward earnings, a record high.

It’s a reminder that markets can get carried away, and history shows how painful the comedown can be. After the tech crash in 2000, the NASDAQ fell 80% and it took 13 years for the S&P 500 to recover its losses.

Echoes of the dotcom bubble

Hofflin sees some uncomfortable similarities between today’s enthusiasm for AI and the speculative excess of 2000. Back then, investors chased “new economy” stories in tech, media and telecoms (TMT). Most of those pioneers never made it.

“None of the themes played out. The market speculated on new technology, but by definition, it’s new - we don’t know who the winners will be.”

While the US has companies genuinely driving the AI revolution, Australia doesn’t. Yet, Hofflin says, we’re behaving as though we do.

Investors here have crowded into software-as-a-service (SaaS) stocks as a proxy for AI exposure, pushing valuations into nosebleed territory. He notes that Pro Medicus (ASX: PME) now trades on a higher enterprise value-to-sales multiple than red-hot US AI names like Palantir or CrowdStrike.

“We don’t have AI stocks, but we’re pricing our proxies sky high,” he says.

For Hofflin, it’s not just about high prices - it’s about what markets are ignoring.

Emerging markets like India and Brazil, where there’s little AI excitement, more value orientated companies trading at cheaper valuations, are performing well. Meanwhile, Australian investors are bidding up anything that looks remotely like a tech play, even when the fundamentals don’t justify it.

Hofflin believes one of these markets is wrong - and it’s unlikely to be the ones with cheaper valuations.

The fallen angels

The dispersion story isn’t theoretical. You can see it in the share prices of yesterday’s market darlings - the “fallen angels.”

Hofflin points to a group of nine companies that were once considered bulletproof: 

• 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)

Two years ago, they were priced for perfection. On average, they traded at double the market multiple. Today, they’ve fallen around 60% from their peaks, with most of the damage coming from valuation compression rather than collapsing earnings.

“Those companies have all disappointed. They’ve gone from a 100% premium to a small discount. The earnings fell a bit, but the big hit came from the de-rating.”

In other words, these were quality businesses that simply got too expensive.

Buying the stocks you used to love

While investors fled, Hofflin and his team at Lazard saw opportunity emerging. Of the nine fallen angels listed above, they’ve bought five.

The most symbolic of those is CSL Limited (ASX:CSL) - a company they haven’t owned in the Lazard Select Australian Equity Fund for more than two decades.

“It’s the first time we’ve owned CSL in over 20 years,” Hofflin says. “It won’t do what it did over the last two decades, but at a 20% discount to the market, it doesn’t need to.”

The others are Mainfreight (NZSE:MFT), Woolworths (ASX:WOW), Domino’s Pizza (ASX:DMP) and IDP Education (ASX:IEL).

Each tells a similar story - great businesses, temporarily on the nose.

Mainfreight, long admired by Hofflin for its culture and execution, has been hit by the New Zealand recession and global trade softness. Domino’s has collapsed more than 90% from its highs as growth expectations deflated. IDP Education fell from $40 to $3.60, where Hofflin bought in; it’s already up more than 80% since.

“Sometimes luck’s on your side, sometimes it isn’t,” he says. “But when the valuations stack up, we’ll be happy to buy.”

The four they haven’t bought - Sonic Healthcare (ASX:SHL), Ramsay Health Care (ASX:RHC), James Hardie Industries (ASX:JHX) and Reece Limited (ASX:REH) - are still on watchlists. Inflation and wage pressures remain headwinds, particularly for the healthcare names.

What's your 'Plan B'?

While momentum continues to drive parts of the market, Hofflin believes the setup today is as attractive for value investors as it’s been in decades.

“The starting point for valuation today favours us enormously,” he says.

He notes that the spread between cheap and expensive stocks is now wider than at any point in the past 40 years. That creates fertile ground for value investors - but also danger for those holding richly priced names.

As Hofflin puts it, every market cycle has its party, but eventually, someone has to drive investors home.

“At the end of the party, you need somebody to throw the keys to you to drive you home. That’s us.”