Value stocks should be the focus in a quantitative tightening cycle and an uncertain economic outlook, while profit-taking on counters commanding excessive valuations may be prevalent, said RHB Research (RHB) in the recent Malaysia Strategy Report.
At the current below-mean valuations, investors should continue to take positions as constant positive alpha generation ideas do exist, even in an uninspiring market, as seen in the outperformance of RHB’s 2022 small-cap jewels.
“RHB Top 20 Malaysia Small Cap Companies Jewels 2022 outperformed the broader market with a value-weighted holding period return of 15.7% since our book launch on 12 May 2022 vs the returns of benchmarking indexes – FBM 70 and FBM SC,” said RHB.
Note that this was despite the extremely volatile market, given the various prevalent uncertainties. There were 11 gainers and nine losers, with stocks from the oil & gas sector making up the majority of winners.
Following a dismal 2022, both the FBM 70 and FBM SC have outperformed the FBM KLCI , thanks to the outperformance of the oil & gas, electronics manufacturing services, technology and glove-related counters.
Meanwhile, the FBM KLCI was dragged by commodity-related stocks and the sell-down from the heavyweight banking sector. Also, the net foreign fund outflow year to date and the intermittent buying from local institutional investors also contributed to the underperformance of the FBM KLCI. There were 10 winners out of 30 stocks in the FBM KLCI, lagging behind winners in FBM 70 and FBM SC .
“Weak corporate earnings on top of an uncertain global economic environment continue to weigh on our outlook. This, and the lack of foreign fund flows and local retail participation contributed to the lacklustre activities,” said RHB.
Both local institutional and retail investors’ year to date total turnover contracted by 5% and 35% for the FBM 70 and FBM SC. However, the trading volume for FBM 70 improved by 17% year-on-year while FBM SC was down marginally by 2% due to the lower share prices, and their focus on more micro and initial public offering names.
Meanwhile, the year to date trading volume and total turnover contracted by 36% and 39% within the big-cap space, as investors exercised caution amid the growing recession risks and foreign fund outflow.
The current below-mean forward price-earnings ratio for the FBM 70 and FBM SC, at 13.7x and 12.4x, suggest that there could still be pockets of opportunity in this space.
On the backdrop of flattish 2.3% growth in RHB’s ex-FBM KLCI basket, compared to 5.3% growth in RHB’s FBM KLCI basket, the valuation gap between the big and small-mid caps of 1.5x may not look attractive.
Nonetheless, the earnings growth numbers are distorted by the prosperity tax and also the significant earnings drop in plantation names. To note, the valuation of the MSCI Malaysia Small Cap Index is on par with the MSCI benchmark index, with a similar elevated valuation trend observed for the MSCI small-caps indexes in markets like Japan, Singapore and Thailand.
RHB advocates investors to focus on value stocks with an eye for growth, healthy cash flow generation and dividends that will prevail in this challenging environment.
Their ideas are focused on domestic-centric businesses, unique turnarounds and growth catalysts, event-driven, and inelastic demand at reasonable valuations.
The sector preference in the small-mid cap space includes consumer staples, consumer discretionary, healthcare, solar related names, non-semiconductor technology names, 3PL logistics and oil & gas.
Risks identified by RHB are the economic recession, inflation, earnings disappointment, liquidity issues, political instability, and ESG-related risks.
