Stock markets, and indeed any financial markets, go through
periods of rotation. This is where money flows from one sector or asset class
to another, as institutions believe one area will start to outperform another.
We see this when recessions strike, for instance, when money flows to consumer
staples stocks and away from technology.
There are many examples like this, and one way that we can
take advantage of these cycles as investors is to buy names that are out of
favor. That means their valuations will be lower than fair value; over time,
that undervaluation can turn into outsized returns for investors.
There are many blue chip stocks trading for reasonable
valuations.
We value stocks by examining their historical valuations
over a period of years and determining if the factors that drove that
historical valuation have changed. For instance, if a stock was valued quite
highly due to exemplary growth, but that growth profile has deteriorated, we
would likely assign a lower fair value than historical. The opposite is true,
of course, but the point is that history is our guide.
In addition, we tend to err on the side of caution when it
comes to assigning fair value, meaning that when we see a stock that is
undervalued according to our model, it tends to be quite undervalued. This
increases the odds of success and decreases the chances of being wrong. Buying
overvalued stocks, by contrast, means the odds of a draw-down are much higher,
reducing potential total returns.
With this in mind, we’ll take a look at 10 stocks below that
screen well for these criteria. Their names, we think, are out of favor today
and, therefore, undervalued and offer great total return potential to buyers.
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