Earnings momentum has provided mixed results in the equity rally since June 2012, Citi writes in a note, and those with historically poor but improving momentum coupled with cheaper valuations are the best picks moving forward.
Companies with the best earnings momentum outperformed the rest of the market in the recent rally, but the ones with the worst momentum also rallied on the back of their good value.
Outperformance has come at two ends of the spectrum, with both quality names with good earnings momentum and value plays with poor earnings momentum both outpacing the rest of the market.
“We believe that investors should have exposure at both ends of the barbell, quality and risk,” analysts at Citi write in the note.
The rally in the second half of last year, fuelled by European Central Bank President Mario Draghi’s promise to do “whatever it takes” to save the euro, was led by banks, who were trading very cheaply -- well below the book value of their assets -- but did not have positive earnings momentum.
This has caused a relative de-rating of defensive growth stocks, Citi say, despite broadly positive earnings momentum, causing them to favour those stocks with a Price to Earnings ratio below their five year average as candidates for mean reversion of the stock price upwards, in line with outperforming earnings.
Featuring heavily in their list are utilities such as RWE, health care stocks like Actelion and food and beverage stocks.
Top analysts are predicting that utilities and consumer staples on the Euro Stoxx 600 will beat consensus estimates for 2012 fourth quarter earnings by 1.2 percent on average, with health care predicted to beat expectations by 0.8 percent, according to Thomson Reuters StarMine data.
Food and beverage heavyweight Unilever, one of Citi’s favoured picks, got the UK earnings season off to a flying start when it reported bumper sales, helping to lift the stock to a record high.
Alongside this earnings quality, Citi still sees value in banks, especially given falling macroeconomic risk. Top analysts expect banks to miss consensus earnings forecasts by 4.3 percent on average for the fourth quarter.
Citi also like stocks that have had negative earnings momentum over the last 6 months but that have turned positive last month, as well as trading below their 5-year average P/E ratio to provide valuation support. This produces recommendations for miner Rio Tinto, and healthcare firm Novartis.
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