PETALING JAYA: Investors should focus on value stocks with an eye for growth, healthy cash flow generation and dividends that will prevail in the current challenging environment, according to RHB Research.
“Our ideas are focused on domestic-centric businesses, unique turnarounds and growth catalysts, event-driven and inelastic demand at reasonable valuations,” the research house added.
In its latest small-mid caps report, it said the sector preference includes consumer staples, consumer discretionary, healthcare, solar-related names, non-semiconductor technology names, third-party logistics and oil and gas (O&G).“We believe 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 the research house.
At the current below-mean valuations, RHB Research said investors should continue to take positions as constant positive alpha generation ideas exist even in an uninspiring market as seen in the outperformance of its Top 20 Malaysia small-cap companies jewels 2022.
They had outperformed the broader market with a value-weighted holding period return of 15.7% since its book launch on May 12, 2022 versus the returns of benchmarking indices, FBM 70 (1.8%) and FBM SC ( down 5.5%).
“This was despite the extremely volatile market, given the various prevalent uncertainties. It’s a testament to our strong team effort, robust fundamental-driven and winning stock-picking strategy.
“There were 11 gainers and nine losers, with stocks from the O&G sector making up the majority of winners,” it said.
Year-to-date (y-t-d), RHB Research noted that both the FBM 70 and FBM SC has outperformed the FBM KLCI, thanks to the outperformance of the O&G, electronics manufacturing services (EMS), technology and glove-related counters, after a dismal 2022 performance. Meanwhile, the FBM KLCI was dragged down 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 contributed to the underperformance of the FBM KLCI, according to RHB Research.
There were 10 winners (33%) out of 30 stocks in the FBM KLCI lagging behind winners in FBM 70 (53%) and FBM SC (49%), it added.
The research house also said weak corporate earnings on top of an uncertain global economic environment would continue to weigh on the outlook.
“This, and the lack of foreign fund flows and local retail participation contributed to the lacklustre activities.”
Both local institutional and retail investors’ y-t-d total turnover (traded value) contracted by 5% and 35% for the FBM 70 and FBM SC.
However, the trading volume for the FBM 70 improved by 17% year-on-year, while the FBM SC was down marginally by 2% due to lower share prices and their focus on more micro and initial public offering (IPO) names.
RHB Research also said y-t-d 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.
It noted that the prospects of peaking inflation and interest rate cycle were among the main causes for optimism among investors this year, albeit various risks such as a potential global recession fuelled by the recent financial-sector concerns. “The current below-mean forward price-to-earnings ratio for the FBM 70 and the FBM SC of 13.7 times and 12.4 times suggested that there could still be pockets of opportunity in this space,” it added.
However, investors should exercise extra diligence in their stock-picking, despite a better risk-reward balance in terms of relative forward valuation given the challenging environment. The risks to the sector include an economic recession, continued fund outflow, higher-than-expected inflation, earnings disappointments, rising risks related to cost escalation, liquidity issues and higher environmental, social and governance-related risks for smaller-cap companies.