Even during bear markets, there are stocks that manage to avoid being caught up in the meltdown. The problem is that, when you finally spot them, it is almost always too late. Once the “winning horse” is identified, investors flock to it, driving up valuations and adding risk to that investment. But not in all cases.
This year, the Morningstar Europe Index NR fell by 9.8% (in Euros, as of 25 November). However, despite the downward trend, a group of European stocks managed to achieve stunning returns over the same period, especially those belonging to the energy sector. But not exclusively.
While investors who had the wisdom (or luck) to bet early on these companies are enjoying the upswing, many of the bear market winners have potentially exhausted their fuel, rising above what Morningstar analysts consider to be their fail value.
Take for example BAE Systems (BA.), a British aerospace and defence company, whose stock listed on the London Stock Exchange. It’s risen 47% for the year-to-date (in Euros).
According to Morningstar stock research, BAE Systems now has a price/fair value ratio of 1.15, which equates to an overvaluation of 15%. The same applies to Danish biotechnology company Genmab (GMAB): the stock gained 20% in 2022 so far and is now overvalued by 27% according to Morningstar analysts.
To find the winning stocks in the bear market that have not exhausted their momentum, we screened European equities covered by Morningstar Research to identify those that have risen at least 10% since the start of the year. Subsequently, we kept only those with a 4 or 5 star Morningstar Stock Rating.
This group has 25 companies. In the table below are the 12 most undervalued stocks among them, as of November 25.
If you want to identify those opportunities with a greater margin of safety, you could look for companies to which Morningstar assigns a wide Economic Moat. Our analysts believe companies with one have a lasting competitive advantage. In the table above, we count two:
Bayer AG (BAYN)
Stock rating: ★★★★★
Economic moat: Wide
Fair value: 76 EUR
Uncertainty rating: Medium
“Bayer reported strong third-quarter results ahead of our expectations, but we don’t expect any major changes to our fair value estimate,” says Damien Conover, director of healthcare equity research for Morningstar.
“Strong crop science prices partly supported the outperformance, but we expect increased competition in 2023, which will likely reverse some of Bayer’s recent gains. However, the crop science business remains well positioned for growth over the long term, led by innovative new products (such as short-stature corn and next-generation trait protection) that help reinforce the firm’s wide moat.
“We continue to view Bayer as undervalued with the market not fully appreciating the innovation at the company and overly concerned about past glyphosate litigation pressures. Beyond the innovation in crop science, Bayer recently introduced drugs (Nubeqa for cancer and Kerendia for kidney disease) that are starting to contribute meaningfully to the top line (representing close to EUR 200 million collectively in the quarter).”
Imperial Brands PLC (IMB)
Stock rating: ★★★★
Economic moat: Wide
Fair value: 2.900 GBX
Uncertainty rating: Medium
“Imperial continues to benefit from weakness in pound sterling, which has benefited the market valuation of the stock this year, but we think upside remains”, says Philip Gorham, director of equity research at Morningstar.
“Our investment case for Imperial is based on a very low valuation, an attractive 7% dividend yield, and belief that the market is underestimating the duration that Imperial’s core cigarette business can continue to generate cash and excess returns on capital.
CEO Stefan Bomhard unveiled a five-year strategic plan in 2021 that will concentrate Imperial’s investments geographically and on emerging categories that are likely to become the largest profit pools in the future.
“The plan essentially recognises Imperial’s place in the marketplace – it is a fast follower, rather than a leader, in most markets. This makes Imperial a different investment proposition than its Big Tobacco peers, particularly Philip Morris International, which is investing in growth and moving away from the secular decline of the cigarette industry.
“Imperial, on the other hand, is likely to be the company more exposed to cigarettes in future, and although it should trade at a discount to its peer group, Imperial should remain a highly profitable and cash-generative business”, says Gorham.
The Broader Group
The broader group of 25 stocks mentioned above, on the other hand, sees four other companies that have done well so far in 2022, remain undervalued and have an established competitive advantage, namely a wide Economic Moat (figures are in Euros, as of 25 November). These are:
London Stock Exchange Group (LSEG)
Stock Rating: ★★★★
Return YTD: 15.7%
Price/Fair Value: 0.83
British American Tobacco (BATS)
Stock Rating: ★★★★
Return YTD: 25.6%
Price/Fair Value: 0.86
AstraZeneca (AZN)
Stock Rating: ★★★★
Return YTD: 25.6%
Price/Fair Value: 0.88
Novartis (NOVN)
Stock Rating: ★★★★
Return YTD: 11.4%
Price/Fair Value: 0.97
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