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CROCI: Seeking elusive revenues

The year 2015 was a year to forget when it came to companies' ability to grow revenues. Globally, 46% recorded negative revenue growth; not a single region managed to diverge significantly from that trend.

Analysts were optimistic at the beginning of the year. Of our global coverage of 825 companies, 83% were expected to grow their revenues; that number is now only 57%. We cannot recall a situation in history when so many companies had a prolonged period of stagnating revenues.

The issue of top-line growth is very important to macro analysis; nevertheless it tends to be ignored. When a company's revenues are expected to fall, it will generally not invest. In such situations, companies instead seek to minimize expenditures as a way of maximizing the value they can create. The problem with this? For the economy as a whole, growth is postponed, putting further downward pressure on companies’ revenues. It is a vicious cycle. Therefore, it is no surprise that the International Monetary Fund (IMF) is downgrading global economic growth just as sovereign yields are hitting record lows. The market is expressing the view that the world economy is facing stagnation.

Equity markets have been surprisingly resilient to these downgrades. Since the beginning of the year, global valuation has risen from an Economic price-to-earnings (Econ. P/E) ratio of 27.3x to 32.6x. One might have expected to witness higher levels of volatility given the turmoil in some emerging markets (EM), such as Turkey, Brazil and China, as well as uncertainty in developed markets (e.g. Brexit, revaluation of yen, turmoil amongst European Financials).

One plausible explanation is that equity-market stability has been provided by the fall in the yield on sovereign debt. This is exemplified by 10-year U.S. Treasuries, whose yield is now lower than the S&P 500 index dividend yield. Our analysis indicates that U.S. corporates have lower financial liabilities and a higher level of profitability. Their dividends are generally not at risk.

In this low growth environment, the apparent conclusion is that investors can afford to simply cash in their dividend coupons and wait for corporate economic earnings (stagnating since 2010) to recover – when that happens, equities may be a better place to be than bonds. This is consistent with our findings in a 2013 report1: since 2000, equities have tended to rise when bond yields rise.

Looking for valuation asymmetries between regions is becoming difficult, as there has been a marked convergence. Japan has seen the most downgrades in revenues, but is also the most interesting region on valuation with the Economic P/E for the median company at 26.9x vs. 30.0x for the U.S., 30.1x for Europe and 32.0x for EMs.

EMs may have had a better performance but we still struggle to find any value in the region from a bottom-up perspective. A positive call must be driven purely by top-down policies. There are signs that companies are at last slowing their capex down, a crucial step on their journey back to value creation. But the recent announcements in China about reviving corporate investment call into question whether there has been the crucial realization that unproductive investments are not good for anyone. Our purely bottom-up view is that any positive performance may be short-lived.

CROCI – an economic valuation method

CROCI is a 20-year old unique proprietary valuation methodology. It is founded on the principle that fundamental investors need to perform a full due diligence on each company they analyze to better understand its valuation and thereby make sound investment decisions. Thus the CROCI process seeks to thoroughly and consistently assess the economic valuation of companies, sectors and markets. This objective framework can then be used to systematically identify fundamentally attractive shares.

Proportion of companies with negative revenue growth2

There has been a marked increase in the number of companies with negative top-line growth this year.

Proportion of companies with negative revenue growth

  2015 2016E delta this year3

United States

52%

38%

22%

Europe

35%

41%

22%

Japan

44%

66%

46%

Emerging markets

48%

44%

22%

Global

46%

43%

26%

2016 median Economic P/E based on consensus forecasts4

Valuations cheapest in Japan, with convergence in U.S. & Europe; dispersions within regions are very wide.

2016 median Economic P/E based on consensus forecasts

  Market Cheaper half Cheapest decile

United States

30.0

24.7

17.1

Europe

30.1

24.1

16.7

Japan

26.9

19.5

14.5

Emerging Markets

32.0

21.9

11.4

S&P 500 Index dividend yield now exceeds 10-year U.S. Treasuries5

U.S. Treasury yields reflect the deteriorating outlook for growth. They are now close to all-time lows.

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1 The appeal of equities and dividends if bond yields rise, 7 May 2013

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2Sources: CROCI, Deutsche Bank AG Filiale London; as of 7/15/16; E = expected

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3Percentage-point change in the number of companies expected to report negative earnings growth in 2016 (from expectations at the beginning of the year)

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4Sources: CROCI, Deutsche Bank AG Filiale London; as of 7/21/16

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5Sources: CROCI, Deutsche Bank AG Filiale London, Bloomberg Finance L.P.; as of 7/21/16

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The CROCI® Investment Strategy and Valuation Group is responsible for devising the CROCI® strategy and calculating the CROCI® Economic P/E Ratios. The CROCI® Investment Strategy and Valuation Group is not responsible for the management of the funds and does not act in a fiduciary capacity in relation to the funds or the investors in the funds.

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