Where to look for attractive valuations and long-term outperformance

Dodge & Cox sees investment opportunities in value stocks, Chinese internet stocks and global stocks outside the US, vice president Lily Beischer said during a Nedgroup Investments Multi-Management webinar.

Nedgroup Investments Multi-Management includes the Dodge & Cox Worldwide Global Stock fund in its portfolios.

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‘We want to own companies at attractive valuations with the potential for long-term outperformance. Those opportunities today appear in the value parts of the market versus growth and internationally, including China, more so than parts of the US market,’ she said.

She added that one of the most exciting investment opportunities was the considerable discount that value stocks trade relative to growth stocks. For example, growth stocks trade at a multiple of 28 times forward earnings, double the price-to-earnings ratio of 14 times for value stocks. The multiples that growth stocks trade at have plenty of room to disappoint, she said.

Value stocks were up 42% over one year, while growth stocks gained 26%.

‘Within this rebound, core value sectors are up significantly. Financials were up over 50%, and energy was up almost 70%. The rebound off the Covid-19 bottom has barely put a dent in that enormous longer-term discount that has opened up for value over the last five years,’ Beischer said.

Dodge & Cox was overweight value stocks, emerging markets and international stocks outside the US, but underweight the US.

Chinese tech

‘Within [emerging markets], the real excitement is China. China is about 4% of the fund by domicile. We remain invested in Chinese internet companies, and we added more positions.

‘These large Chinese internet companies are down 55% from their February peak. That is in contrast to the Nasdaq, which was up 8% over that period. So there is a lot of concern about all the recent regulatory announcements. Then, of course, you have Evergrande, energy shortages and GDP growth questions,’ Beischer said.

‘Chinese internet stocks used to trade at a modest discount to the FANGMAT [Facebook, Apple, Netflix, Alphabet/Google, Microsoft and Tesla] complex, but now they are about half that level.

‘On the other hand, big Chinese tech used to trade at an 80% premium to MSCI All Country World index (Acwi), but now those stocks are about as attractive as the Acwi. But the Chinese internet is expected to outgrow the FANGMAT complex significantly and certainly grow much faster than the Acwi,’ she said.

‘The Chinese big technology companies are fairly critical to China’s goals of self-reliance on technology and technological leadership. We all know these companies invest in critical areas of innovation for China’s future in artificial intelligence, automated vehicles and the cloud,’ Beischer said.

Dodge & Cox believed that many of the issues were not specific to China, including data security, general data protection regulation and anti-monopoly regulations.

‘These are being discussed in major markets around the world. One benefit to China has been that several of the issues and remedies China has identified so far were resolved relatively quickly.

‘We would observe that [Chinese] government officials reached out to investors to clarify the government’s agenda and stressed the importance of private enterprise. These companies are important to the common prosperity goals of China since they improve access to goods and services for large parts of the Chinese population,’ Beischer said.

Dodge & Cox has lowered their expectations for Chinese tech in their models, including around growth, margins, taxes, and the use of free cash flow.

‘Even considering these more conservative assumptions, valuations continue to look attractive,’ she said.

Justin Brown is a journalist at Citywire, which provides insights and information for professional investors globally.

This article was first published on Citywire South Africa here, and republished with permission.