Deutsche CROCI: The Future of Equities is Low Yielding (and Not Cheap)

Buyer beware when approaching equities, especially in emerging markets, a leading bank has said.

(July 29, 2013) — Investors looking to make a quick buck out of rises in equity markets should be aware that the ship offering cheap stocks has probably sailed, analysts at Deutsche Bank have warned.

In the latest note from the European bank’s Cash Return on Capital Invested (CROCI) team, investors are warned to “assess the implications of a prolonged period of subdued economic growth and specifically: The implications of NO top-line growth for companies”.

The team said listed company performance across the board would come under pressure in the short-to-medium term, and although dividends would make up a significant part of equity returns, growth stocks were likely to do better than value-stamped names.

“The foreseeable future is one of low equity returns, in our opinion, and investors should be well served by investment strategies focussing on: Dividends; Sustainable growth (or Survival of the Fittest growth); Selective Distressed Value; Defensive Value; Healthcare and Consumer.”

The outcomes needed by investors should fuel their choices, however. “Regional positioning will be dictated by investment styles,” the team said. “A growth-driven investment style should find the best opportunities in Europe and the US. In turn, we believe Japan would surprisingly be an overweight at the expense of Europe and emerging markets for income investors.”

The team, which has seldom flown the flag for emerging markets in recent times, has also this week told investors that an emerging market “offers no real alternative” to a developed one. The team continues to avoid these growing economies, even proffering red flags over Korea and Brazil.

“Investors may be tempted to buy back emerging markets, but the data clearly show that real earnings growth is no higher than that of either the US or Europe, but capital growth is.” The team asked investors to consider which valuation ratio to use. “The price-to-earnings ratio will tend to over-estimate their real value, as what matters to investors is the cash conversion of those earnings and the free cash flow yield shows precisely that, i.e. that for similar real earnings growth, emerging markets [are] at a significant premium to both US or Europe.”

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