“In the last few years, the biggest gains have been made by mid- and small-cap companies, or the bottom end of the FTSE 100 (INDEXFTSE:UKX). The mega caps have been ignored – they are the elephants in the room, the cheapest part of the market,” says Chris White, fund manager of the Premier Income and Monthly Income Funds in an interview.
That may be a U.K.-specific comment, but could it apply globally?
Phillip Saunders, manager at the Investec Diversified Growth Fund, disagrees, saying that while some of these mega-caps could outperform, many others will ‘languish’ and that as a sector, mega-caps will underperform relative to small-caps, mid-caps and even companies which are large, but not ‘mega’.
The ExodusPoint Partners International Fund returned 0.36% for May, bringing its year-to-date return to 3.31% in a year that's been particularly challenging for most hedge funds, pushing many into the red. Macroeconomic factors continued to weigh on the market, resulting in significant intra-month volatility for May, although risk assets generally ended the month flat. Macro Read More
Do the ‘elephants’ offer value?
“The Last Value Trades,” a report by the Global Strategy team at Citi, says mega caps generate strong free cash flows (FCF) that could provide returns to shareholders through better dividends, buybacks and other shareholder-friendly actions.
“Mega caps look particularly strong on this measure. They generate twice the global FCF margin. A cash-flow obsessed value investor (and there are many) should be looking carefully at the world’s biggest companies right now,” say the Citi experts.
How mega caps valuations stack up
Citi says that global equities have already run up 40% over the past two years and therefore, it is increasingly difficult to find value opportunities. However a comparison of global PE relative to the MSCI AC World index for major regions, global sectors and global mega caps showed seven opportunities that were trading at a discount, as in the chart below:
CEEMEA, Energy, EM Asia, Financials, UK, global mega caps and Latam are all positioned below the equilibrium line, indicating discounted valuations.
Mega caps cheap even by alternative valuation methods
The charts below show that mega caps are cheaper compared to the MSCI ACWI when compared to dividend yield and cyclically adjusted price earning (CAPE), while they trade close to their historical median discount relative to the MSCI ACWI:
But…not cheap on price to book
However, unsurprisingly, mega caps turned up the most expensive on a price/book value valuation, even higher than the MSCI ACWI.
What about fundamentals?
As mentioned in the opening remarks, one of the most attractive features about mega caps are their solid cash flows which can enhance returns to shareholders through various corporate actions. On this benchmark, mega caps stand head and shoulders above the other trades being compared, as per the chart below:
Debt levels and leverage are also the lowest in mega caps compared to the other trades.
This indicates mega caps have “bullet proof balance sheets,” according to Citi.
Mega caps offer attractive valuations, great cash flow and excellent balance sheets. However, “global mega caps are not cheap on a PBV basis and trade at a similar PE discount compared to history. Sure they are cheap but no cheaper than normal. Despite good FCF margin and strong balance sheets, mega caps have EPS momentum below the benchmark,” qualify the Citi analysts.
Investors looking to invest in mega caps could do so through the following:
Schwab U.S. Large-Cap ETF (NYSEARCA:SCHX)
Vanguard Large-Cap ETF (NYSEARCA:VV)
Vanguard Mega Cap 300 Index (ETF) (NYSEARCA:MGC)
Fidelity® Mega Cap Stock Fund (MUTF:FGRTX)