TOL - 8th Apr, 2023
Lazard's Warryn Robertson: These are the 5 best value stocks in the entire world right now
With the world's financial system on fire, what more could you want...
When it comes to the global investment universe today, there's not a whole lot of value.
That's according to Lazard Asset Management's Warryn Robertson, who believes there are currently only 25 stocks in the entire world that can generate returns of 10% or more per annum.
Why so glum? Well, Robertson and the Global Equity Franchise team at Lazard believe inflation and subsequently, interest rates are likely to remain a lot higher (and for a lot longer) than much of the market would think.
"The consequence of that is most likely going to be a recession. Because central banks are walking along a tightrope above a precarious abyss. And the most likely scenario, if you work through it, is a recession," Robertson said.
So which stocks can continue to generate attractive returns in a slowing economic environment - or worse, a recession?
In this wire, Robertson shares how the Global Equity Franchise team at Lazard ascribe value, his macro base case, as well as the five stocks he believes boast the most upside today.
"We've got recessions built in to all of those numbers. And we still think they look good value," he said.
"Now, it could get rocky. I can't tell you when the recession's going to happen ... But, if we can still make those valuations stack up with that pessimistic view of the macro environment, then you're in a good place."
Note: This interview took place on Wednesday 22 March 2023.
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The Golden Rule of investing
There may be some mystique around what portfolio managers do with their days. For some, it's meeting with company management, for others, meeting with prospective clients. But when it comes down to it, Robertson believes it all comes down to two things.
"What we do all day is really simple. We forecast earnings, and we put a multiple on it to come up with a value. Or we forecast cash flows and put a discount rate on it to come up with a value. That's it," he said.
"The Golden Rule explicitly links those two key numbers."
The Golden Rule states that for any given economy, the risk-free rate is the key input that you input into your discount rate so that your multiple is explicitly linked to how fast an economy can grow.
"So, if you think the US economy will have GDP growth of 5% per annum, made up of 2% inflation in the long run and 3% real economic growth, to come up with 5%, then your risk-free rate should be 5% as well," he explained.
This rule has held up well over long periods of time except in recent years when the risk-free rate was close to zero.
"That meant that a lot of analysts and investors ended up having false inputs into that valuation equation," Robertson said.
For example, assuming the economy was going to grow 5-6% per annum forever, but with a 0% risk-free rate, therefore using 0% as the anchor for their discount rate.
"That's kind of stupid. My Dad was a motor mechanic and my Mum would describe herself as a homemaker. You ask my Mum and Dad, 'Why are interest rates so low?' And they would very clearly say to you, 'Well, that's because there's a problem in the world. And we need to make sure that people can take out loans, and the Government want people to spend money'," Robertson said.
"Well, that's not normal. 0% interest rates are not normal."
For those followers of the Golden Rule, a risk-free rate of 0% would be impossible - thus, helping these followers to avoid making "silly" valuation errors, Robertson added.
"It doesn't mean you don't make mistakes. You could get the earnings trajectory wrong. But it means you don't make stupid valuation errors. And that's why it's so important to us," he said.
What does Lazard believe the risk-free rate should be?
So that begs the question, what should the risk-free rate be? As it stands today, Australia 10 Year Government Bonds have a 3.33% yield. 10-year US Treasuries currently have a 3.50% yield.
"I used to whisper, 5%. I would try to mumble it. Because people would just think you were frankly nuts. Now, all of a sudden, we look like the designated driver at the party. Everyone else has been drinking the Kool-Aid," Robertson said.
He believes for valuations you are best served by being conservative and assuming the long-term risk-free rate is 5% in the US, and assume 4% for Europe.
"Why? Because Europe's going to grow slower. Europe doesn't have the productivity growth, it doesn't have the population growth. Japan's even lower, because it doesn't have the productivity growth or the population growth. But critically, it's not zero," Robertson said.
"If you believe it's 0% forever, that's fine. But then, you've got to grow your earnings at 0%. You can't have one without the other. It’s important when you're valuing a company you err on the side of caution, be conservative, making forecasts with an adequate margin of safety. It's how you make fewer mistakes."
So why so high? Well, Robertson and the team at Lazard predict inflation will remain higher for longer than the market expects.
"We think inflation will remain above central bank target ranges for at least the next three, possibly five, years. There is a lot of liquidity that has to work its way through," he said.
"That will mean interest rates will have to go higher in the long run. And the consequence of that is most likely going to be a recession. Because central banks are walking along a tightrope above a precarious abyss. And the most likely scenario, if you work through it, is a recession."
Despite that, Robertson believes the five stocks listed below can still produce returns better than 10% per annum. This may not necessarily be 10% per annum each year in a straight line, but over a three to five-year cycle, he believes that is an achievable target.
"We've got recessions built into all of those numbers. And we still think they look good value," he said.
"Now, it could get rocky. I can't tell you when the recession's going to happen. We assume it's going to happen at some point in the calendar year 2023. And it's not going to be pretty. But, if we can still make those valuations stack up with that pessimistic view of the macro environment, then you're in a good place."
The 5 best value stocks in the world right now
For some clarification, Lazard ranks its investment universe (from more than 1500 stocks to just 250 stocks that are "economic franchises") from those that offer the greatest upside to those with the greatest downside. The top 25-50 stocks with the greatest upside make it into the portfolio. That means the stocks listed below offer the greatest upside of Lazard's global investment universe, ranked from #1 (the most upside), to #5 (the fifth most upside in this investment universe).
"Our aim is to earn 10% per annum out of the portfolio. But what we ideally want is to earn 10% per annum or more out of each individual stock," Robertson explained.
"How much of each stock we own is determined by how big that differential is between what we think it's worth and where its share price is. And as stocks appreciate in price, they move down our rank."
That doesn't mean the list below is perfect. Lazard, just like the rest of us, sometimes gets it wrong.
"It doesn't mean it works every time. We do get stocks wrong," Robertson said.
"But because the market's view is typically three months, and our view is typically three to five years or more, that creates the value opportunity."
So, without further ado, here are the best value stocks in the world right now, ranked from the fifth most upside to the most.
#5. CVS Health (NYSE: CVS)
CVS Health comes in at fifth place on Lazard's ranking scale. The US$93.9 billion conglomerate owns three interconnected businesses.
"It's CVS Pharmacies, which is the biggest retail pharmacy network in the United States. CVS Caremark - a pharmacy benefits management company. And Aetna, which is a health insurer," Robertson explained.
"They acquired Aetna in 2019, and the idea of that was to leverage their pharmacy network footprint. And it allowed them to also provide healthcare at lower costs across the board."
Together, these three businesses create a strong economic franchise, Robertson said. And also all three arms of the business generate "a lot of strong cash flow".
"Here's a business that dominates its industry, and the stock trades on 10 times earnings. And consensus is that it's going to grow earnings at 10% plus for the next three years. So, for us, that's a pretty easy buy," he said.
#4. eBay (NASDAQ: EBAY)
Next on the list is something we have all heard of, and many of us have used, eBay - the US$23 billion e-commerce giant.
"Instead of being an e-commerce retailer to everyone, they have focused their business on five main categories," Robertson said.
"They have 150 million buyers in about 200 markets around the world. But they've got 20 million sellers. And five categories account for more than US$10 billion in gross merchandise value."
These categories include:
- Motor parts and accessories
- Electronics
- Collectibles
- Home and garden
- Fashion
"There are about 19 million of what they call 'enthusiasts' that dominate 70% of that gross merchandise value. Those enthusiasts visit 30 times a year, say, once every two weeks, and spend about US$3,000 a year," Robertson said.
"Focusing on those five categories has meant that they've become much more attractive to advertisers. So, their advertising revenues have gone up to about US$2 billion a year from zero."
eBay also now has an authentication service, which verifies products.
"Buyers really put a lot of value in that. And that's where their online presence is really starting to work for a lot of those buyers."
"In short, being much more focused has meant that they're going to get a lot more repeat customers, which is different from the one-off fashion buyers that they used to get. And it's meant that they've started to turn the business around. You've started to see some decent top-line growth and some decent profit growth as well."
While Lazard ascribes "fairly anaemic top-line growth numbers" of 2% for eBay, it also trades on less than 10 times earnings and is practically debt-free.
"Management is forecasting to produce US$7 billion in free cash flow over the next three years, which it's going to buy back shares with, and/or pay dividends," Robertson said.
"Unlike a lot of IT companies, the acquisitions and divestments they've made have been pretty good. And so we give management a big tick. It's a pretty good business."
#3. Tapestry (NYSE: TPR)
Number three on Lazard's global value scale is Tapestry, the US$9.5 billion parent company to brands Coach New York, Kate Spade New York and Stuart Weitzman.
"We all hear about the Louis Vuittons, we all hear about the Richemonts, the big European luxury brands. Here's a stock that trades on 10 times earnings, not on 30 times, as those others do," Robertson said.
"They 'diworsified' into Stuart Weitzman and Kate Spade. We don't put much credence in the turnaround stories there. Although they are showing some green shoots of actually getting some decent returns out of what they, frankly, overpaid for."
That said, the Coach brand remains strong, Robertson said, and continues to grow its presence in the US, Japan and China.
"It's a business that's not lost money in 50 years," he said.
"A lot of us think about fickle fashion brands. The Coach handbag core brand has made profits every year for 50 years. Now, there's been cycles, but it's been a much more predictable business than a lot of people give it credit for."
#2. H&R Block Inc (NYSE: HRB)
Coming in at second place is H&R Block, a business that Robertson describes as "boring" but trades on only 10 times earnings, pays a 5% dividend yield and generates US$300 million a year in free cash flow.
"One in six tax returns in the United States is completed by one of H&R Block's agents. They do about 20 million of those. They also have an online presence, like TurboTax. They're number two in that space," Robertson said.
Like many businesses, it suffered during the COVID pandemic.
"So, Donald Trump decided that Americans didn't have to lodge their tax return for an extra three months. That meant that, for close to 15 months, H&R Block made no money, because it makes all of its money in six weeks," Robertson explained.
"But guess what happened the next year? They had not one tax return lodged, but two in 12 months. And it made a record profit."
Today, it's back to business for H&R Block. And while it may have fallen out of favour with investors, it continues to pay an ever-increasing dividend each year.
"It's bought back about 15% of its stock in the last three years because it's produced a lot of cash. And people fell out of love with it," Robertson said.
"It's a really simple, easy business, that experienced problems thanks to COVID, but it wasn't permanent."
#1. International Game Technology (NYSE: IGT)
The stock with the most investment upside in the universe, according to Lazard is the US$4.98 billion International Game Technology - the world's leading lottery concession business.
"It's the preferred partner, as they like to call themselves, in 114 countries. And it has owned the biggest lottery concession in the world, which is the Italian Lotto, for more than 60 years," Robertson said.
"It's a great business, trades on about 12 times earnings, and 6.5 times EBITDA."
In comparison, businesses like The Lottery Corp in Australia and FDJ in France trade on 12-16 times EBITDA, Robertson added.
"IGT's three times the size and it trades on half the multiple. Its share price would more than double if it traded close to what The Lottery Corp and FDJ trade on. It's a conundrum that it trades where it does," he said.
"Part of it is because it's really seen as a European company that's listed on the New York Stock Exchange. It's not in many of the indices. It's not in the S&P 500. And so, it goes under the radar.
"But it's really quite attractively priced, produces great cash, and is a really lovely business. It's the stock that we think has the greatest upside in our portfolio."
Learn more
Warryn invests in global-listed companies which he considers to have an “economic franchise”, meaning companies that possess a combination of a high degree of earnings forecastability and large competitive advantages. Find out more by visiting the fund profile below.
Managed Fund
Lazard Global Equity Franchise Fund
Global Shares
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Ally Selby is the deputy managing editor at Livewire Markets, joining the team at the end of 2020. She loves all things investing, financial literacy and content creation, having previously worked for the likes of Financial Standard, Pedestrian Group, Your Money, Sky Business and Sky News.
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Ally Selby is the deputy managing editor at Livewire Markets, joining the team at the end of 2020. She loves all things investing, financial literacy and content creation, having previously worked for the likes of Financial Standard, Pedestrian...
Expertise
Ally Selby is the deputy managing editor at Livewire Markets, joining the team at the end of 2020. She loves all things investing, financial literacy and content creation, having previously worked for the likes of Financial Standard, Pedestrian...
Expertise
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