Value investing has become significantly more difficult over the past 12 months. As recently as a year ago many companies in the ASX 200 appeared undervalued based on their intrinsic value calculated by analyst groups, but with the broad-based rally in the Australian share market last year investors are now being warned that individual stock-picking ability will make a big difference to returns in 2014.
A recent analysis by the team at StocksInValue (SIV) looked at the best picks in their analysis universe and found five quality companies that were undervalued.
The top 5
Based on the valuation method used in the analysis, five quality companies to consider were identified as McMillan Shakespeare Limited (ASX: MMS), Australian and New Zealand Banking Group (ASX: ANZ), BHP Billiton Limited (ASX: BHP), Woolworths Limited (ASX: WOW), and Brickworks Limited (ASX: BKW). StocksInValue rates these companies as between 17% undervalued and 10% overvalued based on 2014 earnings forecasts.
But wait
Valuation is only one piece of the puzzle as the quality of the company and reliability of future earnings will ultimately factor into what each individual values the company at. Foolish investors should always consider downside and upside risks, and assess the company's competitive position before diving in.
The companies
McMillan Shakespeare had a rough end to 2013 when the former Labor government announced changes to the fringe benefits tax which would have significantly damaged the business. In the end, Labor lost the election and the company has returned to normal business. SIV believes that a recent UK acquisition should drive share price growth in years to come and that McMillan remains undervalued after the big 2013 fall.
ANZ's share price has dropped by around 6% so far in 2014 and now represents decent value seeing as it has solid exposure to Asia and one of the biggest and most reliable dividends going around. Risks include a rise in bad debt expenses and a slowdown in Asia.
BHP is well known as a low-cost, diversified miner that is strongly exposed to the growing Chinese population and economy. The dividend yield is around 4% and looking forward it is expected to generate an increase in cashflow through volume growth in years to come.
Woolworths is a Motley Fool favourite with a history of delivering earnings growth year-after-year due to its strong competitive position in the market. Population growth should help to sustain this while the Masters Hardware chain is a potential risk to earnings.
Finally, Brickworks is looking like a good long-term investment, although SIV believe it's currently slightly overvalued. An improving housing market and ongoing development of company-owned land should continue to boost profits.
Foolish takeaway
As all Foolish investors will know, past returns are no indication of future results. Similarly, valuation models are only as good as the estimates put into them for future yearly earnings. Investors should combine valuation models with an analysis of company quality before deciding to buy part of the company.
