Undervalued but not unwanted

Value investing is back in vogue, as investors scour the markets for dividend-rich businesses with mountains of cash that are trading at bargain levels.

Pharmaceuticals, oil and tobacco stocks represent something of a holy trinity for value investors. The consensus is that companies in these sectors are positioned well to weather any further turmoil in the markets due to their solid balance sheets.

Three other sectors gaining attention are technology and telecommunications and Lloyd’s underwriting syndicates, such as Hiscox and Beazley.

Since the start of the equity rally in March, corporate bond funds have been more popular than equity funds with many investors.

But amid uncertainty about the future of the economy, income fund managers are now seeing a resurgence in interest in “value stocks”, which largely missed out on this year’s market rally.

“Johnson & Johnson, Procter & Gamble, Intel and Microsoft. These stocks have been left behind in the rally and you’ll find that some big global brands remain undervalued,” says Tony Nutt, income fund manager at Jupiter.

“Investors still haven’t gone back into equities in a big way. If you’re prepared to take a long-term view, whether it be on Vodafone or Unilever, I have little doubt you’re making good returns out of the value area of the market.”

The 12-month forward price-to-earnings ratio for the oil sector is an attractive 12 times next year’s earnings; the pharmaceuticals sector has a p/e of 11.3; and telecoms has a p/e of 11.5.

“It could be a case of buy now while they’re cheap, because the valuation anomaly won’t last for ever,” says Tim Cockerill, head of research with the advisory firm Rowan & Co.

France Telecom shares, for example, still trade at less than 10 times next year’s earnings, as do Vodafone’s.

The prospects for capital growth are starting to encourage investors in corporate bonds to sell their debt positions and buy into equities. But the yields on offer are also a factor.

Value stocks is that they usually offer attractive dividend yields, and some blue chip companies pay better yields than their underlying corporate bonds offer. Adrian Lowcock, senior investment adviser with Bestinvest, says: “As equities can grow their dividends, the capital can continue to appreciate, whereas bonds cannot grow their dividend so there is more of a ceiling on any capital growth.”

Sharp dividend cuts made in the last year suggest the payouts can only improve over the next two to three years – though increases are likely to be modest.

GlaxoSmithKline offers a yield of 4.75 per cent; AstraZeneca’s is about 5 per cent; Vodafone’s is 5.5 per cent; BP’s is 5.76 per cent and Shell’s 6 per cent.

The gap between income stocks and growth stocks is still relatively wide. Equity income funds returned 33.7 per cent on average since the end of February, while the FTSE All Share has returned 39.98 per cent, according to Bestinvest’s research.

But if the economy is set for further difficulties, as some analysts believe, equity income funds – invested largely in value stocks – are poised to outperform.