A significant dislocation in the stock market is disappearing, and several prominent companies are set to reap the rewards

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  • The profits and stock prices of US companies have been dislocated since the financial crisis, Deutsche Bank analysts said in a recent research note. 
  • But this is changing as investors increasingly shun companies with weaker returns on equity and  dividend payers that are facing more competition from higher bond yields. 
  • The analysts published a list of 10 stocks that could benefit the most, and 10 that could be hurt the most by this trend. 

Investors don’t always reward the most profitable companies by buying their stocks. 

In fact, since the financial crisis, stock prices have largely been dislocated from company profits, according to a recent research note by Deutsche Bank. For example, during the five-quarter-long profit recession that began in Q2 2015, largely driven by energy stocks, the S&P 500 gained 1.5%. A broader decade-by-decade analysis shows the relationship between profits and returns is inconsistent.

“However, their reattachment is finally in full swing,” Luke Templeman, a Deutsche research analyst, said in the note. “That gives investors the opportunity to buy stocks that benefit from the trend and sell those that are hurt. In fact, since the inflection point in mid-2016, our model shows ‘reattachment’ stocks have returned 55%, double the market’s return.”

The dislocation existed in the first place partly because stock prices aren’t only influenced by profits. Also, stock prices are more a reflection of yet-to-be-known future profits than historical performance — hence, the recurring disconnect. 

The analysts found that after the Great Recession, the dispersion of returns on equity was much higher than stock-price dispersion. What that means is that the market prices investors agreed on were similar for many different stocks, even though their profitability varied widely.Screen Shot 2018 06 08 at 1.24.24 PM

Templeman said that other structural factors contributed to this disconnect. He pointed out the growth of passive investing, a rising tide that lifted many boats including some companies that didn’t “deserve” to rally. 

The “post-crisis obsession with dividends” was another contributing factor, according to Templeman. In their hunt for yield, investors turned to stocks with higher payouts as bond yields fell, and leaned into companies even when the fundamentals didn’t justify their share prices, Templeman said.  

But with bond yields and interest rates rising, companies that pay the highest dividends as a share of their earnings are slowly losing their appeal, he added. 

“The result of the recent short-term structural shifts is that the dislocation between returns on equity and market returns will likely continue to converge,” Templeman said.  

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Below is a table showing the stocks the analysts said could benefit or be hurt by this trend. To create the list of stocks that could benefit, they filtered by companies that have a top-quartile return on equity, but have produced below-top-quartile returns over the past year. Conversely, the stocks that could be hurt were in the bottom-quartile of returns on equity, but saw one-year returns above the bottom quartile. 

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Read the full article from it’s original source: http://uk.businessinsider.com/stock-market-price-dislocation-shrinking-creating-opportunity-2018-6

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