A new Morgan Stanley report identifies 40 "mispriced" stocks as a way to play the eventual reopening.
Looking for upside? Check out “mispriced” stocks, say analysts at Morgan Stanley.
According to the bank, not only is the economic recovery “intact” and likely forming a V-shape, there are plenty of pockets where investors have not accurately priced in the coming recovery and eventual reopening—meaning opportunity for investors.
In a recent report, the bank’s analysts first lay out the good news: they expect global and DM (developed markets) GDP to reach their pre-COVID levels “by 4Q2020 and 3Q 2021, respectively.” The analysts further point out that retail sales in many areas are running above pre-COVID levels; that ‘PMI new orders to inventory level,’ which they call a leading indicator for the global cycle, is at multi-year highs; and overall U.S. household personal income “already reached 2% above pre-COVID levels in August.
Furthermore the analysts write that “The Morgan Stanley Biotech team expects we will see efficacy data from the 3 leading vaccine candidates in November…with a vaccine broadly available to the general population in 2Q21.” They conclude: “We would expect a broad-based dissemination of a vaccine to ultimately clear the way for the recovery to gain further momentum via the normalization of out of home activities.”
But even if you believe that relatively sunny outlook, there is the competing sense that the market may already be overvalued. As Fortune‘s Shawn Tully explained recently: “Imagine the 500 as S&P 500 Co., an enterprise that earns $120 for each share outstanding. What should the share price be? At the close on Monday, October 13, the S&P hit 3534, just 1.4% off its all-time high reached in early September. So by our reckoning, the S&P is putting a 29.5 multiple on its most probable future profits. Since 1990, its P/E has averaged 21.8; over the past 60 years, the norm is a much slimmer 16.9.”
Which is why Morgan Stanley’s analysts set out to hunt for names that haven’t yet been swept up in the market’s enthusiasm. They started with a quantitative screen estimating where stocks may be valued at the end of 2021 assuming they “hit analyst numbers and see a return to normalized multiples.” They kept the universe to companies with a market cap of over $1 billion, a high rating by a MS analyst, names that were at least 15% down from pre-COVID highs, and have significant EPS and price upside. Companies that have high premiums to the S&P 500 overall were excluded to “avoid growth stocks that have grown into their multiples.”
The 40 names that fit the bill?
“Our list can be categorized into 2 subsets, roughly equal in size: (1) those tied primarily to a reopening and return to out of home activities by consumers—airlines, hotels, restaurants, casinos—and (2) those tied primarily to a general recovery in economic activity—trucking and equipment, banks and consumer finance, brand based apparel,” the analysts wrote.
The bottom line? This list is “a way to take reasonable exposure to the themes of reopening and recovery into 2021 while avoiding excessive concentration and stocks that have already priced in the fundamental upside into next year.”
