By Jack Hough

Peter Bates, manager of the Global Select Equity Strategy at T. Rowe Price, isn't worried about relatively high U.S. stock market valuations. "I don't buy the argument that you're not going to make good returns in the U.S. stock market the next 10 years," he says.

Cases about corporate reform in Japan and deep discounts in Europe are less convincing to Bates than the likelihood of the U.S. economy outpacing inflation by a couple of percentage points a year, aided by population growth, including through immigration. He views the economies of Japan and Europe as likely to produce zero or even negative growth after inflation. "The U.S. stock market is still the best wealth-creation vehicle in the world," he says.

Bates also rejects the argument that a pricey U.S. market makes today a good time to favor value stocks. "I think the discussion and debate about value versus growth is really nonsensical," he says. Better to look for companies with high gross margins, a sign that customers value the products; high cash generation relative to sales; strong competitive advantages; and long runways for growth.

Among Bates' favorite U.S. stocks now are Corebridge Financial, Steel Dynamics, and PG&E. In Europe he likes Germany's Sartorius.

Corebridge is a life insurer and annuity seller spun off from American Iinternational Group. Shares recently traded below seven times earnings, versus close to 10 times for MetLife. Bates likes that the company has opportunities to cut costs, and that with bond yields higher than they were in past years, it can earn attractive returns on its investment portfolio without taking on much credit risk.

"The market is saying, 'Oh, rates are going to fall, your spreads are going to compress,'" says Bates. "But while we wait for that to happen, they're going to make a lot of money and they're also being very disciplined with that capital, because they're paying dividends, they're paying special dividends, and they have even bought back some stock."

Steel Dynamics, at under 13 times earnings, is a growth stock that gets categorized as a value stock, says Bates. The company has a relatively new plant in Texas that is operating at 60% and rising, versus a more typical 90%. It is also building a Mississippi aluminum plant that will open next year.

"The U.S. market is short aluminum, meaning we have to import aluminum to satisfy our demand," says Bates. "And I would argue that the [capital] they have spent is really being ignored by the market, because you haven't seen any of the benefits of this aluminum plant, and you're not going to until 2026, because the plant will initially have losses in '25. But it creates a really nice growth driver."

California utility PG&E was forced into a bankruptcy restructuring due to wildfires started by poorly maintained equipment. Now there's a legal structure in place to deal with that liability, and as it gets proven out, shares should rise to trade more in line with valuations of other regulated utilities, says Bates.

"That's a very safe, stable name that normally wouldn't have enough upside to want to own it because they're only a 6% to 8% EPS growth story," he says. But the [price/earnings] discount can be narrowed, and I think that puts you in a 10%-plus return bucket, which makes it attractive."

Sartorius makes tools for drug discovery and production. "You're not betting on the specific pharmaceutical company like an Eli Lilly or a Pfizer," says Bates. "You're selling the picks and shovels to the miners. You don't care which miner wins and hits gold." Earnings for Sartorius ballooned during the Covid-19 pandemic due to vaccine demand but have since fallen by more than half, leaving shares looking pricey at 50 times earnings. Now growth is poised to resume; Wall Street predicts a doubling of earnings over the next four years.

Write to Jack Hough at jack.hough@barrons.com

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October 24, 2024 15:51 ET (19:51 GMT)

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