Longleaf's LLPFX Mason Hawkins, FPA Crescent's FPACX Steve Romick, and Leuthold's Doug Ramsey LCRIX all see value in slices of the equity world today, and they shared their insights at the 2012 Morningstar Investment Conference.
Europe Looks Cheap
Unsurprisingly, Europe was a hot topic of conversation. Ramsey sees incredible value in the European equity market at the moment. By his calculation, the price/normalized earnings ratio for the MSCI Europe index is now under 10 times. This is approaching 2009 and 1982 levels and is well below historic norms. Europe also looks very cheap compared with the S&P 500, which is trading at around 19 times to normalized earnings. Ramsey thinks that even if the European situation gets much worse, investors will still end up on top. Hawkins agreed that P/E ratios in Europe seem very low, particularly when you consider how low interest rates are today.
Romick thinks the market is assuming that Europe will never come back and is ignoring the core earnings power of many European names. He signaled out his holdings in advertising firm WPP Group WPPGY and automaker Renault RNSDF.
Are Margins Sustainable?
One of the big question marks hanging over corporate earnings has been if today's record level of profitability is sustainable or if margins are going to revert back to historical levels. Romick thinks that there has been a structural shift in margins that will allow profitability to remain at higher-than-average levels. The change is being driven by moving low-margin manufacturing overseas and focusing on higher-margin licensing and tech industries. He did caution that even though margins won't go all the way down to the long-term average, they will likely fall from today's peak.
Hawkins agrees that margins should be structurally higher now because of the business shift and the fact that many foreign subsidiaries are now accounted for using the equity method which boosts net income but doesn't increase revenue. He also thinks that as margins erode, a stronger economy will help boost an anemic top line and keep earnings strong.
Will Rising Rates Kill Stocks?
There was some disagreement about the impact of rising rates on the equity market. Hawkins and Ramsey were not worried. They don't see rates rising until the economy looks much stronger than it does now. In that environment, earnings would be increasing quickly enough to mitigate the damage.
Romick disagrees. He thinks that as Treasury investors (particularly buyers like China) find better uses for their funds, the U.S. might be forced to pay a higher rate even if growth is anemic and inflation is under control.
None of the managers has any short-term predictions about what the market or the economy is going to do. But all felt that the classic value-investor mantra of buying high-quality companies with a large margin of safety remains the best way to prosper in this market.
Jeremy Glaser is the Markets Editor for Morningstar.com.
