Contrarian value investors are always on the look-out for shares that the market has overlooked. In times of economic uncertainty – when stock prices become erratic – good quality stocks can become cheaper. The question is whether Sumitomo Heavy Industries (TYO:6302) is currently one of them.
Sumitomo Heavy Industries is a player in the market’s Machinery, Equipment & Components sector, with a share price currently trading at 2447.
Buying good quality stocks at cheap prices is a tried and trusted stock market strategy – but it isn’t always easy to tell the difference between a genuine bargain and a value trap. Often, it’s the quality of the stock makes all the difference.
The good news is that Sumitomo Heavy Industries scores well against some important financial and technical measures. It’s a large-cap share with strong exposure to two very influential drivers of investment returns: high quality and a relatively cheap valuation.
To understand where that shows up, here’s a closer look:
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Good quality stocks are loved by the market because they’re more likely to be solid, dependable businesses. Profitability is important, but so is the firm’s financial strength. A track record of improving finances is essential.
One of the stand out quality metrics for Sumitomo Heavy Industries is that it passes 5 of the 9 financial tests in the Piotroski F-Score. The F-Score is a world-class accounting-based checklist for finding stocks with an improving financial health trend. A good F-Score suggests that the company has strong signs of quality.
While quality is important, no-one wants to overpay for a stock, so an appealing valuation is vital too. With a weaker economy, earnings forecasts are unclear right across the market. But there are some valuation measures that can help, and one of them is the Earnings Yield.
Earnings Yield compares a company’s profit with its market valuation (worked out by dividing its operating profit by its enterprise value). It gives you a total value of the stock (including its cash and debt), which makes it easier to compare different stocks. As a percentage, the higher the Earnings Yield, the better value the share.
A rule of thumb for a reasonable Earnings Yield might be 5%, and the Earnings Yield for Sumitomo Heavy Industries is currently 15.8%.
In summary, good quality and relatively cheap valuations are pointers to those stocks that are some of the most appealing to contrarian value investors. It’s among these shares that genuine mis-pricing can be found. Once the market recognises that these quality firms are on sale, those prices often rebound.