This blog is part of a new series on Institutional Investor entitled Global Market Thought Leaders, a platform that provides analysis, commentary, and insight into the global markets and economy from the researchers and risk takers at premier financial institutions. Our first contributer in this new section of Institutionalinvestor.com is AllianceBernstein, who will be providing analysis and insight into equities.
Safety, stability, solid evidence of current profitability, high earnings quality and positive price momentum—these are the qualities investors appear to be seeking this year. The stocks that score highest on these measures aren’t necessarily the stocks with the best long-term return prospects, even though they’re the ones that appear to be safer harbors in rough waters. But let me back up a few steps.
About Valuation Ratios...and More
Ultimately, whether you’re a value, growth or core equity investor, you’re looking for a discount — a stock price that’s too low given your view of the company’s longer-term prospects. There are many ways to arrive at such a determination. Our managers combine a deep understanding of industry and company fundamentals with an assessment of various return factors. Our value managers rely more heavily, but not exclusively, on valuation measures such as price/book value, price/earnings and price/sales ratios (usually, but not always, cheaper is better). Our growth managers pay greater attention to earnings growth, earnings revisions and return on investment.
Some of these factors — price/book value, for example — tend to be predictive of outperformance over a longer time horizon. Other factors, such as earnings revisions and share-price momentum, are more useful short-term. But over the long term — a period of decades — virtually all these return factors have pointed to superior results, albeit not at the same time. And they tend to work better in conjunction with one another than they do individually. It pays to diversify exposure to fundamental return factors, just as it pays to diversify exposure to asset classes, sectors and securities.
Where Are We at the Moment?
Understanding that the performance of return factors isn’t always consistent is an important part of risk management. When there are indications that one investment style is out of favor, it’s prudent to make sure that the portfolio manager is paying greater attention to some of the factors on the other side of the aisle. As of the end of June this year, however, little has worked as history would suggest. Globally, the cheapest stocks, based on classic valuation ratios, underperformed the most expensive — and even superior earnings growth proved to be a negative indicator of relative returns. Investors are apparently looking for qualities that they can bite into right now, like high dividend yield and return on equity. That approach carries its own risks, but it’s understandably popular in a market that’s even harder to read than normal.
Andrew Chin is Global Head of Quantitative Research and Investment Risk at AllianceBernstein
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all Alliance Bernstein portfolio management teams.
