The level of market volatility seen in 2022 can be disorienting for even the most experienced investors. In challenging markets such as these, we can use valuations to gauge the attractiveness of the stock market over the next few years.
With a current valuation multiple of 15.5x their expected profits in the coming 12 months (forward PE ratio[1]), global equities experienced a significant derating in 2022. Valuations were as high as 25x in 2020 and 2021, reaching levels not seen since the late 1990s. At the current multiple, we are below the 10-year average and broadly in line with the 20-year average, so these are reasonable entry points for medium- to long-term investors.
In the short-term though, uncertainty is high whilst the future path for inflation and interest rates remains unclear. If US inflation[2] decreases to 3% or below by the end of 2023 (as is currently expected by the market), it is very likely that interest rates will come down and valuation multiples expand.
However, if inflation proves to be more stubborn than expected and plateaus at 5% for example, central banks could maintain their hawkish stance for longer and put further downward pressure on valuation multiples in the short term. In our opinion, inflation will remain the key driving factor of market sentiment and valuations in 2023.
As company valuations decreased in 2022 with bigger falls experienced by smaller size companies, we have seen several mergers and acquisitions announced by larger, more established companies looking to grow. In the last two months of the year, we saw several bids for fast-growing companies that offer innovative and greatly sought-after sustainable products and services.
The following three examples highlight, in our opinion, just how attractive current valuations are for the sustainable themes in which we invest.
Healthcare
Fast growing companies in this sector saw significant profit-taking in 2022 after a strong period of outperformance during the pandemic. Abiomed, is an innovative and profitable US company which has developed Impella, the world’s smallest heart pump. By November 2022, Abiomed’s year-to-date share price change was down circa -30%. Johnson & Johnson, the world’s largest healthcare company, saw this as an opportunity and made a $17 billion bid to purchase the heart pump manufacturer, representing a 48% premium to where shares were trading.
Sustainable foods
Denmark’s Novozymes is the largest discoverer, manufacturer, and marketer of industrial enzymes in the world. Its enzymes have a vast array of applications, spanning food, agriculture, and healthcare. In December, Novozymes announced a merger with Chr. Hansen, another Danish company, which supplies bacterial cultures and enzymes across the food sector. The deal will likely lead to Novozymes solidifying its position as a leader in sustainable food production at a time when supply chain weakness and resource security is at the fore. Novozymes has proposed paying a 49% premium to Chr. Hansen’s market value, which before the announcement was down -14% in the year-to-date.
Technology
Berkshire Hathaway’s legendary founder, Warren Buffet, is well known for his disciplined investment approach and his caution vis-à-vis technology stocks. In November, Berkshire Hathaway announced a $4.1 billion investment into Taiwan Semiconductor Manufacturing Company, the world’s largest manufacturer of semiconductors. Whilst Warren Buffet hasn’t commented publicly on the deal, the company trades on a cheap valuation – shares were down -36% in the year-to-date. It is a leader in its field and has solid fundamentals – all of these are likely to have attracted Buffett as an investor.
Well positioned
With an expected economic slowdown and recession ahead, we believe that large corporates and investors will be bringing back their attention to companies that can achieve strong and sustainable earnings growth.
In our view, a lot of these opportunities can be found within the healthcare, sustainable food, and technology industries and the recent drops in valuations make those even more attractive, particularly for medium- to long-term investors. We firmly believe that the EQ Portfolios are well positioned to benefit.
[1] Price divided by 12-month forward consensus expected operating earnings per share, Source MSCI, Index: MSCI AC World Index, December-2022
[2] US Consumer Price Index