The Quality Connection
For some investors, value stocks are seen as a good way to position for a macroeconomic recovery. But we think that this is the wrong mindset today because the size and speed of a macroeconomic rebound depends on how countries emerge from the coronavirus—something no investor or epidemiologist can predict with certainty. Many companies are facing significant risks and could become value traps. Even with many countries coming out of lockdowns and starting to reopen their economies, we don’t know how long this crisis will continue and we’re only just beginning to see the impact of the recession. For many companies, there are valid concerns about their ability to survive.
But some companies will successfully overcome these short-term challenges. Those with more resilient businesses, strong balance sheets and better profitability to support solid free cash flows should be well positioned to deliver long-term returns to patient investors. Top-notch management teams are also essential for steering through tougher times.
Looking Beyond the Controversies
Companies like these can be found in various sectors facing controversy because of the crisis. For example, concerns about depressed construction activity have pushed down shares of companies across the sector. But United Rentals, which rents construction equipment in North America, has more flexibility than peers to manage equipment and order cycles, as it did successfully during the GFC.
The slowdown of industrial activity is weighing on manufacturers. However, some market segments may see demand rise in a post-coronavirus world. If governments invest more in rail infrastructure as demand for air travel decreases, train manufacturers such as Alstom in France could benefit.
Even within the stricken air-travel industry, not every company will be pushed to collapse. AerCap, the Ireland-based airplane leasing company, was considered vulnerable to a near-shutdown of global air travel. Yet the company effectively provides liquidity to airlines by leasing its fleet; if an airline goes bust, AerCap gets its plane back. And with a newer fleet of shorter-haul aircraft, AerCap might be in the right place to help the impaired global airline industry cope with the new reality.
Value investing doesn’t have to rely on an economic recovery. By finding companies with higher-quality attributes in industries facing controversy, we believe investors can position for a long-term recovery of value stocks without taking on excessive risk in a highly unpredictable market environment.