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Neil Woodford Argues That Stocks Are Undervalued — But Is He Right?

Equity markets remain one of the few areas where undervalued assets can still be found,” star investor Neil Woodford wrote in a note on Wednesday.

Here’s his thinking and why he may well be right on many of the topics he touched upon — perhaps not, though, on the prospects for some of his top holdings, such as BAE Systems, Imperial Tobacco and Legal & General. 

A False Sense Of Security

The premise is that Mr Woodford acknowledges inherent risk for financial assets in a market caratherised by low interest rates.

In the first 300 years of the Bank of England’s history, interest rates averaged nearly 5% and never fell below 2%. In the financial crisis of 2008/09, however, they retreated below 2% for the first time in history and have remained at 0.5% since March 2009,” Mr Woodford said, adding that with equity markets revisiting historic peaks in recent months, investors could easily be lulled into a false sense of security about the state of the global economy. 

Mr Woodford blames loose monetary policies, namely QE — “a controversial policy“, as he labels it. 

The first symptoms and cracks haven’t shown as yet. 

The problem has been apparent since the aftermath of the credit crisis: money pumped into the financial system has inflated financials assets, but the so-called ‘transmission effect’ of money moving from financial markets to the real economy hasn’t actually taken place, leading to a sluggish growth in real world where I believe that real wages in the West will have to grow at a much faster pace than in the past to de-lever our Western world, while boosting consumption and savings. 

Without an improvement in underlying economic fundamentals, if you keep driving asset prices up, in the end you create a financial asset price bubble“, Mr Woodford also noted.

Crunch? What Crunch? 

A market crash is not around the corner, we both agree on this matter, and while there are “large areas of over-valuation (…) there are enough attractive opportunities out there to build a diversified portfolio“, both among smaller players and larger entities. 

Some dependable sources of dividend yield and dividend growth are also undervalued, sometimes profoundly so.

Where are there bargains, then? 

To name but a few, his CF Woodford Equity Income Fund portfolio is invested in:

  • BAE Systems: its stock looks a bit pricey, while currency headwinds, among other things, suggest you should avoid it now, in my view.
  • Imperial Tobacco: I’d rather choose British American Tobacco, whose relative valuation is much more attractive. 
  • Legal & General: I’m not interested, based on its fundamentals, trading multiples and regulatory risk in the sector. 

Finally, Mr Woodford talks of “over-valuation of bond markets” compared to the “under-valuation” of certain high-quality, dependable growth stocks. I share his view, although pockets of value can easily be found in the bond market, too, if you are willing to take some calculated risks. 

Bonds may or may not be your preferred choice, but then if you are interested to know more about high-quality, dependable growth stocks, I'd strongly recommend a free investment report published by our Motley Fool teamwhich includes a few value plays trading at attractive multiples, some of which have also attracted the attention of Mr Woodford. 

The balance sheet, P&L and cash flow statements of these companies -- as well as projections on cash flows, growth rates and profitability -- suggest that their stocks could continue to rally well into the end of next year and beyond, delivering pre-tax returns north of 20%, excluding dividends.  

Our research is completely free and comes without obligations only for a very limited amount of time, so click here right away to find out more about their identities and prospects. 

Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.