So Where Are the Equity Values?

As anyone who follows the markets knows, stock bargains are hard to come by these days. The market's recent record highs might make investors feel good about their equity holdings. However, for those looking to trade into new opportunities, or for those who have had cash languishing on the sidelines for months or even years, these are challenging times indeed.

Estimates for the market's overall fair value suggest it is trading at a slight premium. A look at this site's Market Fair Value page, which includes data derived from our equity analysts' fair value estimates for the stocks they cover, suggests stocks were trading at 1.03 times their fair value, meaning they are 3% overvalued, as of the end of trading July 21. However, Morningstar recently developed an even broader valuation measure for stocks that assigns fair value estimates and other metrics to virtually all stocks, not just those covered by our analyst team. The Quantitative Morningstar Rating for stocks is calculated using an algorithm designed to predict the Morningstar Rating for stocks that one of our analysts would assign to a stock. These so-called quant ratings have been available to Morningstar's institutional customers since 2013, and there are plans to integrate them into Morningstar.com in the future.

In the meantime, this week we dive into some of this quant data to try to find pockets of opportunity in today's value-scarce market. After all, as Morningstar experts discuss in our midyear video report, uncovering value in today's market requires even more digging than usual.

The quant data below is as of June 30. As a point of reference, the quant data for all U.S. stocks as of that date calculates that the market is 5% overvalued--continuing a trend toward overvaluation that has persisted for more than a year.

Morningstar breaks down its quant valuation data in various ways, including by style valuation, market cap, moat rating, and geography. As we look over the numbers, we'll identify some stocks, funds, and ETFs that provide exposure to the most undervalued segments of the market. In addition, we will single out segments that are overvalued and, therefore, bear watching if they represent significant holdings within your portfolio. Keep in mind that our fair value estimates for individual securities are fluid and can change at any time. But the following snapshot of broader valuation trends can serve as a guide to that additional research suggested by our experts. 

Style
A look at stock valuations by Morningstar Style Box breakdown using the quant ratings produces some interesting results. Among the most dramatic is the extent to which growth stocks have become overvalued.Growth stocks, in general, were about 9% overvalued at the end of June, whereas value stocks were about 1% overvalued. (Here and throughout the rest of this article we express valuation in terms of percentage above or below fair value rather than using the convention found on the Market Fair Value page and elsewhere on Morningstar.com.) Of course, one expects growth stocks to carry higher valuations than value stocks given the nature of each group, but the fact that even value stocks are now considered overpriced says something about how hard it is to find value in the market today.

The only quadrant of the style box that is not overvalued, according to the quant data, is large value, at less than 1% below fair market value. Premium Members can find a list of large-value funds that carry Morningstar Analyst Ratings of Gold, Silver, or Bronze by clicking  here. (Only funds that are currently open to new investors are included.)  And a list of large-value ETFs whose holdings appear relatively inexpensive can be found by using our  ETF Valuation Quickrank tool.

Market Cap
Large-cap stocks (up 3.8%) appear to be less egregiously priced than mid- (up 8.8%) and small-cap (up 6.6%) stocks, which isn't terribly surprising given that smaller stocks have outperformed larger ones over the course of the current bull market. The fact that mid-caps have become more overvalued than both large- and small-cap stocks is noteworthy, however, suggesting that stocks in the $1 billion to $8 billion market-cap range (as Morningstar defines mid-cap) are among the most overpriced.

Sector
In addition to the quant data above, we looked at sector valuations based on stocks covered by our analysts; the thinking being that this data, rather than the quant sector data, would better allow us to surface ideas for which we have analyst coverage. This is the same data you'll find on the Market Fair Value page by clicking the sector tab. The following information is as of July 21.

Most Undervalued: Financial-services stocks, at 1% below fair value, are the only undervalued sector, albeit slightly, with basic materials and energy stocks close behind at fairly valued. For a list of 4-star financials stocks--meaning those trading below their fair value--Premium Members can click here. Currently there are no 5-star financials stocks. Our analysts also like iShares Global Financials ETF (IXG) for access to the sector.

Most Overvalued: Industrials, technology, and utilities--all up 8%--followed by real estate, which is up 6%.

Moat Rating
While quality doesn't usually come cheaply, in today's market it's a relative bargain--at least as measured by stocks with wide Morningstar Economic Moat Ratings, meaning those with the strongest sustainable competitive advantages. The quant algorithm assigns moat ratings to stocks based on what an analyst would likely assign to them. According to Morningstar's quantitative ratings for all U.S. stocks as of June 30, wide-moat companies are overvalued by 3.9% while those with narrow moats are 6.2% overvalued. Those with no moat are 6.4% overvalued. Premium Members interested in seeing which analyst-recommended funds have an average moat rating of wide--meaning their portfolios include lots of high-quality, stable companies--can find the list here.

Geography
Outside of the U.S., bargain stocks also are hard to come by. European stocks trade at a premium, with most other regions close to fairly valued. Country-level data reveals a bit more variation.

Most Undervalued: The most undervalued markets, based on the quant data, come with major caveats. Both Russia and Iraq were trading at a 6% discount as of June 30, but both carry high or extreme fair value uncertainty ratings, meaning it's very difficult to establish precise fair value estimates for their stocks. On top of that, there is significant geopolitical risk as the former deals with the crisis in the Ukraine and the latter faces renewed internal conflict. Other markets selling at a slight discount include Brazil (down 5%), Bangladesh (down 4%), Turkey (down 2%), Australia (down 1%), and China (down 1%).

Most Overvalued: Denmark and India lead the pack here, both at 10% overvalued. Other overvalued markets of note include Indonesia (up 8%), Saudi Arabia (up 7%), and Spain (up 6%).

Premium Members can find out the degree to which their equity funds have exposure to these markets by clicking on the Portfolio tab on a fund's Morningstar.com Quote page and then clicking on the Premium Details link near the top of the page. Scroll down to the World Regions--Country Breakdown section, and click on any regional category to see a breakdown by country.