Which sectors, stocks will outperform in 2024?

As style-neutral managers, we constantly seek relative value, assessing the multiples we pay against earnings growth rates. Our goal is to avoid value traps – seemingly cheap stocks with no growth potential – and growth traps, where high multiples are paid for overly ambitious growth prospects.

Healthcare sector: A prescription for success

Currently, we see significant prospects in the healthcare sector. Our analysis involves comparing sectors' relative value to their potential growth, market averages, and historical multiples. We've recently shifted from a 13% underweight in 2018 to a 6% overweight position now. It's like finding a hidden gem in a treasure hunt—healthcare's forward P/E ratio has dropped from a hefty 38 times to a more reasonable 27 times.¹

Our change of weighting over this time demonstrates our investment process tends to unearth relative value opportunities and we capitalise on them when it does. We believe two factors have influenced healthcare's recent de-rating: increased long-term bond yields pressuring high multiples and concerns about demand impacts from GLP-1 diabetes drug.² However, we believe the latter is overstated, considering the unique impacts on our specific healthcare company exposures.

Diagnosing the next big winners

Our recent investment in Sonic Healthcare (ASX: SHL) is driven by its impressive digital infrastructure, AI technology, and robust leadership. With a focus on specialist and hospital markets in pathology, coupled with a strong balance sheet fortified by COVID-19 testing profits, SHL is well-positioned for future acquisitions and enhancing shareholder returns. At present valuation, we believe these factors are being underappreciated by the market.

ResMed’s (ASX: RMD) valuation has notably halved from its recent peak in 2021 of 36 times to 18 times forward EV/EBIT.³ While GLP-1 drugs have divided market participants the most with this company, anticipating what future clinical trials will reveal, we believe today’s price is also not factoring in RMD’s market-leading offering, structural growth tailwinds and strong free cash flow generation. Over a longer time horizon, we see further opportunity for value creation to be achieved from capturing their growing addressable market, extending industry market share against competitor Philips and expanding margins as high-cost legacy supply contracts struck during COVID-19 rolloff.

Cochlear: Tuning into future growth

Similarly, we believe Cochlear’s (ASX: COH) value, while optically high by market participant standards, underappreciates their long runway for growth. It is estimated that of the 460 million people with a hearing disability, there are 15 million people with severe to profound hearing loss.⁴ In terms of market penetration, less than 5% of that 15 million have received treatment. This means COH has the potential for strong growth for many years to come, provided that it can maintain its market-leading position. This is coupled with a revenue profile not tied to general macro-economic conditions and the desire to reinvest up to 13% of sales back into the business to maintain and extent their competitive advantage.

Consumer Staples: The comfort food of investments

Another sector of interest is Consumer Staples, appealing for two reasons. Firstly, the looming tighter credit conditions, rising interest rates, and growing unemployment in 2024 are likely to bolster the sector's defensive earnings. Secondly, it trades at a historical discount to the market, with above-average dividend yields. Even with a possible monetary easing in 2024, the delayed effects of 2023's monetary tightening make this sector a focus for the next year.

Treasury Wine Estates: From tariffs to triumph

Within consumer staples, we highlight Treasury Wine Estates (ASX: TWE). Its strategic shift from China post-tariff implementation to geographical diversification has strengthened its premium wine business. The possibility of tariff removal on Australian wines in China, coupled with its recent U.S. acquisition, presents long-term investors with a short-term opportunity to acquire this high-quality franchise.

Another name is Endeavour Group (ASX: EDV). Following increased gaming regulations and lower sales, EDV's valuation has declined from 20x to 14x forward EV/EBIT.⁵ With plans to increase EBIT by $150m+ in the Hotels division and a diversification strategy, we anticipate positive market reactions to EDV's evolving business model.⁶ This is further supported by their share of gaming being a smaller % of Hotels revenue moving forward as Food & Beverage is expected to outperform over the next 5 years.⁷

The Lottery Corporation (ASX: TLC): The safe bet for turbulent times

We are positive on the long-term outlook for TLC. While S&P defines TLC as a Consumer Discretionary company, we see gaming spend as being quite defensive and more akin to a Consumer Staple definition. This combined with TLC’s loyal customer base and a strong brand name, we expect the company to generate a resilient revenue profile throughout the economic cycle, with further growth to be driven by product innovation, game changes and omni-channel delivery. Over a longer investment horizon we see TLC capable of improving margins through their continued investment into digital and online markets.

In the investment race of 2024, we're putting our money on healthcare and consumer staples. It's not just about following trends; it's about finding those sectors that are as dependable as a trusty old friend, yet as exciting as a new adventure.

References

1 & 3 & 5 Source: FactSet.

2 GLP-1 (glucagon-like peptide 1) diabetes drugs is a well-known concept regarding the current Healthcare Sector.

4 Source: World Health Organisation (WHO). (VIEW LINK)

6 & 7 Source: EDV December 2023 Investor Day Presentation. (VIEW LINK)