A portfolio manager who’s outperformed a major value index for over a decade shares 4 cheap stocks that the market’s overlooking

When it comes to stock-picking, portfolio manager Scott Rosenthal of Hotchkis & Wiley Capital Management has a sharp eye.

Under his leadership, the firm’s Hotchkis & Wiley Global Value Fund (HWGAX) has outperformed global value benchmarks, yielding a 9.58% average annual return after fees since its launch in 2011. In contrast, the MSCI World Value Index, which tracks large and mid-cap value securities, has returned 7.15% annually over the same period.

The secret behind Rosenthal’s success is his ability to find attractive investment opportunities in market areas that investors are underestimating.

“We are looking to buy businesses whose earnings power, and ultimately value, is underappreciated by the market and not appropriately reflected in the market price today,” Rosenthal told B-17 in an interview.

Contrary to what might be taught in Econ 101, Rosenthal doesn’t think markets function completely efficiently.

“Market participants make mistakes for a variety of behavioral reasons,” he said.

This allows Rosenthal to take advantage of market mispricings and score high-quality investments at attractive prices.

Market disconnects

Speaking of mistakes in the market, Rosenthal thinks the current composition of the market is untenable and due for a correction. He says value spreads — or the valuation difference between one specific group of securities and another — are at extreme levels reminiscent of the March 2020 market meltdown or the dot-com bubble. Namely, a select few tech names are trading at unsustainably high valuations, and the rest of the market is not.

While there’s been chatter on Wall Street about a broadening of the market as the valuation of the other 493 stocks in the S&P 500 catch up to the Magnificent Seven, Rosenthal’s not sure how much higher valuations can rise.

“We don’t think the equal-weighted S&P or any kind of index ex the Mag Seven is at an extremely low valuation,” Rosenthal said.

He also thinks it’s likely that Mag Seven valuations to deflate: “Historically, when you see excesses in an asset class or a subsector of the market, part of the way those excesses are relieved and the way those gaps narrow is through share price decline.”

4 overlooked opportunities

The market’s valuation gap might seem worrying, but it also creates opportunities to buy into less crowded areas of the market and realize gains, in Rosenthal’s opinion.

Below, he shares 4 investment opportunities that he believes are trading below their true potential, making them a great buy for their current price. They are all constituents of the Hotchkis & Wiley Global Value Fund (HWGAX).

Human capital management solutions provider Workday (WDAY) is one of Rosenthal’s top picks.

Although tech is one of the market’s hottest areas, the last year has not been kind to enterprise software, with the subsector lagging behind semiconductors and hardware. However, Rosenthal believes Workday has a strong business model and delivers a product with a high customer retention rate, resulting in sticky recurring revenues. He points to Workday’s increasing market share as it acquires customers moving their operations to the cloud and the company’s robust balance sheet as indicators of an investment with long-term potential.

The healthcare industry has some undervalued companies as well. Rosenthal holds CVS (CVS) in his portfolio.

He believes CVS stock has been unfairly punished due to investor pessimism over negative sentiment in the retail pharmacy business at large. However, CVS has been shifting its offerings mix in the direction of its health insurance business, which Rosenthal thinks investors haven’t priced into the company’s valuation.

Another name in the healthcare space that Rosenthal likes is Medtronic (MDT), a medical technology company that sells products such as cardiac devices, insulin pumps, and surgical tools.

Rosenthal likes the business because of its track record of reinvesting cash flow into its core operations and believes the company can post steady earnings growth and margin expansion consistently into the future.

There are opportunities in international markets, too. Nippon Sanso (NPXYY) is a Japanese oil and gas company that Rosenthal believes is undervalued.

Not only is Nippon Sanso benefiting from consolidation in local Japanese energy markets, it’s also been able to integrate new members into its management team who have guided the company to make beneficial acquisitions. Combined with the structural tailwind of corporate reforms within Japan, Rosenthal believes this Japanese company’s stock is well-positioned to appreciate in the coming years.