July 30, 2012
|Mark Finn, manager of the T. Rowe Price Value Fund|
The equity markets have been inconsistent at best in 2012, surging out of the gate but then retreating in the second quarter. This uncertainty has left many equity investors frustrated and with a sense of déjà vu given last year's midyear retreat. In a recent interview, Mark Finn, manager of the T. Rowe Price Value Fund, explains where these fluctuations are coming from and the ways in which bottom-up investing can identify quality opportunities in a challenging market.
From a macroeconomic perspective, economies are still slumping, fiscal problems are still working themselves out, and political battles are still dominating headlines. Nowhere is this more true than in Europe. Finn notes that the ongoing fiscal turmoil in Europe has weighed on markets around the world, and investor concerns worsened during the second quarter as the chances of Greece leaving the eurozone grew. Financial weakness in Spanish banks along with high borrowing costs in the peripheral countries were key reasons for second-quarter losses.
Finn predicts that the euro crisis could affect markets for a few years. There is a serious risk of Greece exiting the eurozone, and regional lawmakers will need time to design comprehensive solutions to the problems of the member countries. The same could be said about the fiscal and economic challenges in the U.S., China, and many other markets.
Behind the headlines, however, companies based in the United States have been generating strong balance sheets, with earnings measures surging 100% since hitting a market low in March 2009. Corporate profits are close to record highs. Finn also mentions that many stocks are trading at roughly 13 times earnings, which is relatively low on a historical basis.
However, Finn notes that it's important to look beyond the numbers to make solid long-term investments in this market. One potential problem is that, while profits have increased, revenues have remained relatively flat. Many companies have improved their earnings through cost reductions and efficiency gains. While these efforts are impressive, they cannot be sustained indefinitely. As such, profits could lose ground unless revenues improve. If profits slip and revenues don't recover, stocks may not look quite as inexpensive in a couple of years' time.
Finn's strategy is to find companies with legitimate potential for rising earnings that are trading inexpensively compared with the market, their competitors, or their own history.
He identifies pharmaceutical companies as a positive example of his approach. In 2010, investors shunned major pharmaceuticals because many of them were about to lose their exclusive patents on key drugs. Yet Finn felt that their consistent cash flow, dividend yields, and low valuations made for a strong long-term opportunity. The benefit of that opportunity has been realized as several drug companies have improved their research and drug-development pipelines through mergers.
Financial stocks, says Finn, may present that kind of opportunity now. The sector as a whole has an average valuation close to its lowest point in five years, and investors are still highly focused on the regulatory environment and the major missteps of the recent past. Still, there are many companies in this sector that have strong, repeatable revenues and rising opportunities, from the big banks to companies like rating agencies and student loan underwriters. Finn also identifies individual stocks in the energy, technology, industrials and business services, and consumer discretionary sectors that he feels offer strong opportunities for long-term investors.
Finn reiterates that, for a value investor, market volatility can help create new opportunities for those focused on fundamentals and the long term. The global economic challenges are weighing on markets now, but they are also cutting the prices on many companies that are well positioned to succeed going forward.
As Finn explains, "if you're willing to look two to three years out, there are some real opportunities within the market…Through the fundamental work that we do with our analysts, we feel we'll be in a position to take advantage of those opportunities."
Stocks and sectors may not perform in line with the managers' expectations. All funds are subject to market risk, including possible loss of principal. Stocks with value characteristics carry the risk that the market will not recognize their intrinsic value for a long time or that they are actually appropriately priced at a low level. Funds that invest overseas generally carry more risk than funds that invest strictly in U.S. assets, due to factors such as currency risk, geographic risk and emerging markets risk. Because of the concentration in rapidly developing economies, investing in emerging markets involves a high degree of risk. Diversification cannot assure a profit or protect against loss in a declining market.