Investors tend to think of pan-Asia as a growth story — and with good reason. Most Asian countries are growing their GDPs at double or more of the annual growth of developed markets. Most investors go to Asia in search of this growth story. But in our experience, Asia offers equal and perhaps superior opportunities for value investors.
It seems counterintuitive. How is it possible for economies that experience double-digit growth to present deep value opportunities for investors who follow the tenets of Graham & Dodd? Several factors combine to make this so. First, companies in Asia are judged almost solely on their growth prospects, and the markets have little patience for stocks of companies that are growing but miss lofty quarterly targets (expanding, say, at 12% to 15% instead of 18% to 20%-plus annually). So these stocks can get beaten up very quickly. Second, many companies in Asia pay solid dividends, with yields as high as 6% to 10%. Taking the opportunity to invest in good companies with good earnings streams at good value provides the value-minded investor with rewards over the long term.
The nature of many high-growth Asian markets provides an unusual opportunity for the value investor. Because most outside investors go to Asian markets for growth, and most local investors focus on growth and momentum investing as well, one ends up with a situation where high-quality companies can be significantly mispriced. As a matter of fact, in our experience these markets offer the value investor a level of opportunity not seen in the more developed markets, where value investing is typically practiced.
|Exhibit 1: Summary of CAGR (%) based on P/E: 6/30/02 - 6/30/12|
|Quintiles by P/E|
|Statistic||Q1||Q2||Q3||Q4||Q5||Universe||Q1 - Q5|
|E. Asia, ex China, India & Japan||23.6||19.2||16.1||12.4||5.6||11.5||18.0|
|E. Asia, incl. China, ex Japan & India||21.3||18.1||15.4||10.0||4.1||11.8||17.2|
|E. Asia, incl. China & India, ex Japan||23.6||19.4||17.1||10.9||3.8||12.9||19.8|
|Note: Quarterly rebalancing; minimum $25m market cap.|
The table above illustrates this, showing the 10-year compound returns for each of the Asian, American, and European markets divided into quintiles based on price-to-earnings ratios, with the lowest quintile representing stocks with the lowest price-earnings ratios. Note that the lowest quintile (the value quintile) returns a significant premium in all markets, but that the premium is by far the largest in Asia.
We find a recurrent cycle where high-quality, strong-franchise, strong-management businesses get mispriced because of a temporary earnings blip caused by a supply chain disruption, a distribution problem or a poor product launch. Any factors that result in an earnings growth decline cause a sharp price drop of the underlying security, even if the problem is clearly short term in nature. In other cases, where the problem might be of longer, or indeterminate term, one is often well paid via dividend to wait for the company to arrive at a solution.
One example that comes to mind is a company that made cases for laptop computers. This company suffered a significant decline in sales based on fears that the iPad would displace laptops, but the company recovered relatively quickly when that disruption did not occur, and all the while the stock was paying a roughly 6% dividend. Another example is an exhibition company that, at one point after being punished by the market because of an earning miss, had two-thirds of its market cap in cash, an 8%-plus dividend yield and a 4x to 6x p/e ratio. And the company had grown at an average of 22% over the previous four years. This company later returned to its normal earnings cycle and rerated to a p/e north of 18.
At the other end of the opportunity set are companies that are overlooked in spite of high profitability and free cash flow, because they are just not growing “fast enough” to be of interest to the local markets. One example was a company that maintained the conveyor belts at the Singapore airport. It was a very profitable, nice little company, but needless to say it did not have much in the way of growth prospects given that there is, and probably will only ever be, one airport in Singapore. This company had a very healthy dividend yield, one that made the investment attractive in and of itself, but it also had a young, competent and aggressive management team. The portfolio manager's bet, therefore, was that he would do well for a while just receiving a dividend, but that the ambitious management team eventually would find an avenue to grow the business. That turned out to be the case about two years later when the company won a contract for the maintenance of an airport in northern China. With that announcement, the company all of a sudden became a “high growth” market darling and the portfolio manager exited his position at the new, much higher growth multiple. n
This article originally appeared in the October 1, 2012 print issue as, "Asia's growth markets can offer superior value".