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Market correction bargains: two value stocks for your portfolio

bargain shares bear market

In my August column I wrote about how the bull market had been running hard for 10 years and that a correction or even a bear market would eventually come.

Two months later it seems it has arrived.

October was a volatile month with most of the dramatic moves to the downside. The ASX officially entered a correction, defined as a 10% fall from the previous high, and there may well be more to come.

The triggers for this correction have largely been driven by global events, so some of the reaction is sentiment based. However, there are also factors that will impact local stocks, at least in the short term.

This is the time in the cycle when value investors’ eyes light up. Value investors pride themselves on being able to see through the fear and panic in markets to the underlying long-term opportunity.

They also delight in the fact that some of the great businesses they admired but were unable to commit to because the price was too high are suddenly available at a discount.

Like a shopaholic on Boxing Day, they are giddy with excitement at all the bargains before them.

My September article discussed ARB (ASX: ARB), concluding that it was a very well run business but the price was too high.

I concluded with the statement that “if we witness a market correction and the price of ARB falls further still it may present a rare opportunity to pick up a great business at a respectable price”.

With the price dropping to $17-$17.50 during October, I decided that that opportunity had presented itself and bought some shares.

Another stock that is worth a second look is Magellan Financial Group (MFG).

Magellan’s share price has swung up and down in recent years, and has retracted about 14% from its high on October 4. It tends to make sudden moves based on the market sentiment at the time and right now that sentiment is negative.

Meanwhile, aside from a slight dip in 2017, profits have been growing strongly.

Most importantly for a funds management business, funds under management have increased from $20 billion to $75 billion over the past five years.

Market returns and Magellan’s returns relative to the market will impact revenue but these are generally short-term effects. Part of its revenue is also derived from performance fees, which by their nature are not consistent and some years may be absent completely.

In the long term the main business driver is funds under management and this hinges on reputation – a reputation that it will continue to deliver strong performance, the reputation of the investment team, especially Hamish Douglas, and the overall integrity of the business and the people within it.

A scandal like some of the things we have seen coming out of the royal commission would devastate a business such as Magellan’s.

Magellan has built the capital in the business to the point where it does not feel it needs much more.

Therefore it has increased its dividend payout ratio to 90%-95% of earnings. That means at current prices the dividend yield is around 6%.

The forecast PE ratio is under 15 which, while not at bargain levels, certainly does not look expensive.

The market downturn may have further to play out yet but value investors should keep an eye on their favourite stocks and take the opportunity to pick them up or add to their holdings when they look like a bargain.

The author’s related parties have holdings in ARB and MFG.

Written by Chris Batchelor

Chris Batchelor

Chris Batchelor CFA is executive manager of SMSF Direct at
SuperConcepts.

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