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November 21, 2014

Is There Hidden Value in Equity Markets Outside The U.S?

by Sridharan Raman.

As the U.S. markets hit new highs, we look at large and midcap companies in regions around the world to judge whether market expectations are in line with analysts’ growth expectations.

Not surprisingly, the recent run-up in stocks in the U.S. has more or less aligned the market expectations for growth with analyst expectations. In all the other major regions around the world, we see market expectations for growth running below what analysts expect. That could be a sign of nervousness — and hence a discount anticipating any unexpected shocks. On the other hand, investors might be overly pessimistic and there could be good value in these markets.


Source: StarMine

What’s going on in emerging Europe?

In the chart above, the largest differential between market expectations for growth (as calculated by the StarMine Intrinsic Value (IV) model) and analyst expectations for growth is in emerging Europe. In part that is likely due to the geo-political uncertainty surrounding Russia.

Analysts expect the earnings growth rate in the region to be just 3.6% for the next five years — but the market expectations for growth are much lower. In fact, at current prices and using the IV model, the market is expecting earnings to shrink by -13.8% every year for the next five years.

Russian companies that represent almost a third of all emerging European large and midcap companies could be driving this market pessimism with market expectations 24 percentage points below analyst estimates. That seems rather pessimistic, even for a region that is experiencing political instability, and could possibly present some value plays.

Emerging Asia Pacific is next with an 8.2% differential followed by developed Asia Pacific at 7.3% and developed Europe at 5.5%. In each of these cases, the market expectations are below already lowered analyst expectations. Let’s look into the sectors in these regions to see if there are any that look especially cheap or expensive.

Market 1

Source: StarMine

Sector analysis

In every region except emerging Europe, it looks like the Healthcare and Consumer Staples sectors may have rich valuations, with market expectations for growth exceeding analysts’ expectations. With a flurry of global mergers, it looks like healthcare companies may be expensive, possibly trading with a takeover premium.

As recently as this week, we saw Actavis plc (ACT.N) agreeing to buy Allergan Inc. (AGN.N) for $66 billion in cash. Those kinds of valuations are having a positive impact on other drug makers and hence the market expectations may be ahead of the actual growth expectations for the sector.
The Consumer Staples sector is also seeing a lot of market optimism, although it has not seen as many mergers and acquisitions.

The one exception to the rule seems to be Emerging Europe, where market expectations have been lower across the board. Developed Europe seems to be fairly valued with market expectations aligned with analyst expectations.

Market 2

Source: StarMine

Bargain hunting

On the other end of the spectrum, it looks like Energy and Financials around the world seem to be undervalued by the markets. As you can see in the chart above, there is a large differential between market and analyst expectations in every region around the world.

The difference for Financials is greatest in the Asian regions, which could possibly be attributed to market fears about shadow banking and the faltering real estate market in China. Many Chinese banks trade on the Hong Kong exchange.

The market expectations for growth in the energy sector are 14 and 12 percentage points lower than the analyst expectations in emerging and developed Asia Pacific. As oil prices fall, investors may be getting jittery about the Energy sector, more so than analysts who have lowered estimates already for the sector. Emerging and developed Europe have the largest differentials at 23 and 11 percentage points respectively, likely because of the proximity to Russia, one of the largest provider of oil and gas to the region. We will choose some specific examples in these regions and report on their valuation in the coming weeks.

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