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How to find value in the US stock market

HL Fund Manager, Ziad Abou Gergi, explores how to find value when investing and shares his latest views on the US stock market.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

While US inflation fell to its lowest level for almost a year yesterday, it’s still well above the Federal Reserve’s 2% target. Add in the cost-of-living crisis and we’re having to think twice about how much we pay for everyday items.

Firstly, is it cheap or expensive? And secondly, is it good value for money?

Buying investments should be no different. It’s all about finding quality companies at a fair price.

HL Fund Manager, Ziad Abou Gergi, explains how to find value when investing and shares his latest views on the world’s largest stock market – the US.

This article isn’t personal advice. If you’re not sure what’s right for you, please seek financial advice. All investments fall as well as rise in value, so you could get back less than you invest.

Value and price – what’s the difference?

One of the main challenges investors face is defining a fair price for the value of a company or a stock market index.

Value and price are two very different things. A big mistake investors can make is to think a lower price means better value. Just because a company or stock market is cheaper than the other, it doesn’t necessarily mean it’s better value. Cheap isn’t always cheerful.

A famous quote from one of the most successful investors ever, Warren Buffett, sums it up well.

“Long ago, Ben Graham taught me that ‘Price is what you pay; value is what you get.’ Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down”.

The key message is simple. Price alone isn’t an indicator. Investors need to consider the quality when comparing the price of a stock (or socks) to its value. Only then can we decide if an investment ‘looks’ cheap or expensive.

How to spot if something’s good value

As consumers, we’re normally pretty good at weighing up the value that most products offer us. We can quickly judge if something’s cheap or expensive.

When investing in shares, one way (and far from being the only way) to understand the value added by a company to its shareholders is to calculate the return on shareholders’ equity (ROE).

It’s the net income (after tax) generated by a company divided by its shareholders’ equity. The table below shows the ROE for each regional market expected by analysts over the next 12 months.

Region ROE – 12m forward
Japan 8.7%
UK 13.2%
USA 26.3%
Europe ex UK 11.7%
Pacific ex Japan 11.2%

Source: Bloomberg. MSCI indices. Data correct as of 31/12/2022.

The US market is by far the one that generates the highest ROE. The Japanese market generates the lowest. This difference could be explained by a number of factors, like profitability of the companies in the index or companies’ shareholders friendliness. Please note this is over a short time period and there are no guarantees this will happen.

Now looking at the valuation that’s applied for each market, and more specifically, at the price relative to the book value, the picture comes with no surprise. The US market has the highest price-to-book value and Japan has the lowest.

Key figures shouldn’t be looked at on their own though – it’s important to understand the bigger picture.

Region Price to Book – 12m forward
Japan 1.1
UK 1.5
USA 3.4
Europe ex UK 1.7
Pacific ex Japan 1.6

Source: Bloomberg. MSCI indices. Data correct as of 31/12/2022.

The market has efficiently allocated the highest valuation to the highest quality. This makes sense, but it isn’t always the case. Sometimes investors apply a discount or premium depending on the sentiment towards a company, sector or region.

One question which might naturally follow is has the market applied this relationship between valuation and quality consistently across different regions?

Bringing it all together – the bottom line

The US market currently has a higher valuation relative to other markets. However, we think this is to be expected as it’s a reflection of its higher profitability and growth potential. The market is applying a discount or premium for some other regions, but not significantly on the US market.

There’s no reason to expect the valuation gap between the regions to change, unless it’s driven by a change in the market’s expectation about their profitability or growth. Price and value are two sides of the same coin, and one cannot exist without the other.

Overall, we think investors looking to build a diversified portfolio should consider investing in the US for the value offered from high-quality companies and continued long-term growth potential. We think it’s simply too big to ignore.

How to build a portfolio

Looking to invest in the US?

Explore an innovative way to invest in the US with HL's new fund, put together and managed by experts.

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The HL US Fund is managed by our sister company Hargreaves Lansdown Fund Managers Ltd.

You can also find a full list of US funds available to invest in by selecting the ‘North America’ sector on our fund finder tool.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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