The word "volatility" has been commonly used to describe the stock market this year.
The fear of increasing interest rates, escalating trade disputes with China, and potentially overpriced technology company valuations have driven stock prices mostly lower during the final few months of 2018.
One sector that has certainly taken the brunt of the market's wrath has been robotics. Robotics stocks have sold off across the globe. Japanese-based THK (THKLY 4.26%) has fallen 38% during the past six months, while German-based KUKA Robotics is down 45%.
A disconnect from the fundamentals?
However, the sell-off of robotics companies appears to be disconnected from the excellent fundamental performance of their underlying businesses. As an example, the average price/earnings ratio of a basket of 10 of Japan's largest robotics companies (which includes THK, FANUC, Yaskawa, and several others) recently decreased by 35%, even though the earnings per share of the companies on this list grew by an average of 157% during the same time period!
Huge disconnects like these -- where stock prices are dramatically falling even while company performance is significantly improving -- can be an opportunity for investors. Brian Gahsman, the portfolio manager of the AlphaCentric Global Innovations Fund, believes investors should consider putting money to work in the robotics sector.
In the following interview, Gahsman explains why robotics companies have been selling off and what has been driving their improved performance. He also names a few international robotics companies that should be on investors' radar.
A partial transcript of the conversation is included below.
Motley Fool Explorer lead advisor Simon Erickson: Well, speaking of opportunities, Brian, something else that you've been looking at closely lately has been a reduction in the valuation metrics of a lot of these robotics companies. Not just in the medical field, but just more broadly based for robotics companies. Their P/E ratios are dropping. I know that we had a broad based sell-off of the market and tech in general in the last couple of weeks, but is it more specific to robotics, and what do you think the market is focusing on in this recent sell-off and contraction of those P/Es?
Global Innovations Fund portfolio manager Brian Gahsman: Well, there's a couple factors involved in that. One being if we just look at the recent volatility, many of these robotics and automation companies; some of the largest investors are passive ETF and with the nature of that in a space, globally, that has pure play about 170 names in it, when we've got these large passive ETFs that are buying and selling these names and holding large weights in them, any time that we see volatility, these funds are going to sell. And with the massive inflows that they have had, which do increase the PE ratios in these individual stocks, when there's a sell-off, technology and biotech are usually the first ones to get hit and it adds to the selling pressure when the ETFs are forced to sell because of the outflows.
And so, that is one contributing factor the decrease in the valuations, just over the past couple months. Obviously what everyone else is aware of is the tensions with China and the tariff talks are, to an extent, could be very accurate. There are the PMI, the purchasing managers in China I know are sitting on the sidelines a little bit to wait until this gets hashed out. And so, those consistent orders and the growth that we were seeing have been put on hold this year, throughout these talks, but I think that you need to reiterate or look at the fact that the growth is continuing and China is not the only country. The United States is largest consumer of these Japanese robotics and automation companies. China and Asia are the second, followed by Europe being the third, but the Asian Pacific area, that includes India. And India is increasing and ramping up at a huge rate with their adoption of robotics and automation.
So the growth is continuing. I don't know if you'd want to get into the actual valuations now, but just for a sampling: I took 10 of the largest robotics and automation manufacturers in Japan and since March of this year, the average P/E change, they've dropped by 35%. We've seen some of the largest companies -- Harmonic dropping from trading at 70 times, dropping down to 30 times. You've got FANUC trading at, they're down to 26 times now. Omron trading at 16 times. These are significant drops in P/Es.
So, we have to compare that to something, right? Because if you're buying a bunch of garbage and the valuations go down, well, there might be a reason for that. But you have to take that rapid decrease in P/Es and you've got to compare that to earnings, because the average estimated earnings for those same 10 stocks, 157 [percentage change in earnings per share]. Now if you compare those changes to, say, the FANG stocks. So, the average on the FANG stocks, the average P/E change since the same time period, instead of 35% it's negative 3.3%. And now you compare that with the estimated EPS average of those companies and you've got 5% compared to the 157% in these Japanese names.
So, when you compare that P/E change with the earnings, with the growth and with the continued demand from all over the world increasing, in India and increasing in the United States, this is a excellent opportunity to buy these stocks. We have to look back to third or fourth quarter of 2016 to have touched on buying these companies at such a discount. And prior to that, probably 2013, 2014 when global adoption really started happening.
None of us know what's going to happen with these trade tariffs in China, but we do know that China has an increasing demand. They're going to continue purchasing these robotics and automation systems, at what momentum or what rate, that's to be determined yet. But I think at the end of the month there's some conversations being had to maybe figure out a solution with China.
And so I guess my point is that with this incredible reduction in the valuations and the steady increase in earnings from these companies, it will be fantastic if we reach a trade deal with China, but taking China out of the equation, we're still looking at a space that is growing much more significantly and much more attractively than any other group or theme of investments that you could possibly invest in. Now, on top of this, if there is some sort of a deal struck with China here at the end of the month, I do not expect that discount or that drop in P/Es to last for very long as soon as any sort of a deal is made with China and then we are, once again, on a exponential growth path with robotics and automation.
The point is, it's still moving significantly with or without China being on the sidelines right now.
Simon Erickson: Yeah. And Brian, just to recap those numbers again, you said that since March, the FANG stocks dropped 3% in the P/E ratios that they have even though their earnings are up 5%, compared to robotics, those 10 Japanese companies that you're looking at, P/E ratio has dropped by an average of 35%, even though they've grown earnings at 157%. Is that right?
Brian Gahsman: That is correct.