Large-cap multinationals are poised to move onto investors' radars after having been left behind in the market rally that started in 2009.
As the world economy and stock markets grapple with issues including overall slow growth, Europe's sovereign debt crisis and the surge in commodity prices caused by Middle East tensions, multinational giants such as Nestle, Coca-Cola, 3M and Unilever are expected to grow their earnings and reward investors with bigger dividends.
"If you said give me the one equity theme for the next year, I would say global mega-caps," iShares global chief investment strategist Russ Koesterich says.
Koesterich says equities and multinationals will be supported by a number of factors, including the ongoing economy recovery, earnings and cheap valuations.
"First of all, we do think that the global economy is in a self-sustaining recovery. Most leading indicators are positive and telling you that the global economy will expand somewhere between 4 per cent to 4.5 per cent in 2011," he says.
"A lot of that is obviously driven by the emerging markets, but even in developed markets we see pockets of growth that should be between 2.5 per cent to 3 per cent, including the US, Australia, Singapore and Germany, so there are some large countries where we do expect good growth.
"The second factor that is supportive, particularly for earnings, is that we do think that profit margins which are by and large above average will remain that way."
While production costs have jumped due to the surge in oil and commodities in 2011, margins will be supported by slow wages growth in developed markets and near record low borrowing costs.
Koesterich says multinationals appeared particularly attractive because investors gave them little attention since the market rally that began in March 2009.
"The last two years have been largely characterised by what's known as the risk on trade," he says.
"And what's interesting is no matter what asset class you look at generally there has been a preference for risky assets. As a result . these large global mega-cap companies have been largely left behind.
"Not that they have not gone up; they have just gone up much less than everything else and as a result they look cheap."
Fidelity Growth Discovery Fund portfolio manager Jason Weiner says the large companies that make up the Russell Top 200 Index are trading at 13.1 times projected earnings for the next 12 months.
In comparison, the Russell 2000 Index for small-cap stocks is trading at 17.6 times forward earnings.
To put these numbers in perspective, the historical average price-to-earnings ratio for mega-cap stocks since 1979 as represented by the Russell Top 200 Index is 14.3, Weiner says.
"This same average ratio for the Russell 2000 small-cap index is 15.9," he says.
"This tells you large-cap names are cheaper than small-cap names relative to historical averages and on an absolute basis."
He says small caps tend to do well in the early stages of an economic recovery, but the rebound is in its more mature stages now and facing multiple changes.
"I think the argument you would make is that the current economic recovery is not all that strong and it's been difficult for companies to grow earnings," he says.
"Corporate profits are facing the pressures of inflation. It's tough sledding right now and when it's tough sledding, I think you may want to be with the big caps.
"I try to look at what's been happening in the world recently and then consider the companies that I believe have the best armour to fend off the threats facing the world economy. I would argue large-cap global companies have been in a better position to deal with those challenges than small companies."
Large companies are also well placed to benefit from the fast economic growth occurring in emerging markets and coping with inflation.
"A big company can think ahead and recognise that China and India are important, make the necessary investments and be a player in those important markets. I feel it's harder for a small company to marshal those types of resources quickly," Weiner says.
"In terms of inflation, being a big company generally means you're an industry leader, and that can mean you have more pricing power than the small players.
"If you have pricing power, you're probably in a better position to make price increases in your more buoyant markets and handle price pressures in your weaker markets. If you're a small regional player, you might have to take whatever circumstances are dealt to you."
Peters MacGregor Capital Management chief investment officer Wayne Peters says large multinationals are safe investments and may provide some of the best risk-adjusted returns over the next five to 10 years.
"Our overriding theme is the protection of capital and the purchasing power of that capital in an environment which at some stage may become highly inflationary," Peters says.
"So we are favouring companies that have entrenched competitive advantages, very strong balance sheets with little to no debt, are number one or two in their respective industries and their return on invested capital is above the market average."
The firm's Global Fund has invested in food producer Nestle, retail giant Walmart and pharmaceuticals and medical devices manufacturer Johnson & Johnson.
Walmart currently trades at 11 times forward earnings and a quarter of its profits are coming from countries outside North America, a segment that is growing very strongly, Peters says.
"Johnson & Johnson is another one of our picks because a large component of its revenue is coming from international markets and its earnings are less sensitive to the overall economy," he says.
"Its medical device division represents about 40 per cent of market value and is growing very strongly. So their earnings are largely related to the design and product cycle as opposed to the economic cycle.
"We believe companies like Wal-Mart and Johnson & Johnson will be able to maintain their earnings growth even through a period of low growth or stagflation, which we're seeing in some of the western countries currently."
Magellan Financial Group chief executive Hamish Douglass says large multinationals provide Australian investors with diversification and opportunities they simply cannot access through companies in the local market, which predominantly comprises financials and resources.
In addition to investing in companies that are profiting from the emerging markets consumption boom, such as Kraft and fast food restaurant operator Yum Brands, the Magellan Global Fund has bought into several technology giants to access unique investment themes.
The portfolio has snapped up shares of financial services technology companies, including Visa, MasterCard, American Express and PayPal owner eBay, as they are set to benefit from the rapid shift to a cashless society.
In developed markets such as Australia, the United Kingdom and the US, around 60 per cent of all transactions are conducted in cash, while in emerging markets consumers pay for nearly everything using notes and cheques, according to the McKinsey Global Payments study in 2007.
It is estimated global personal consumption expenditure totalled US$36 trillion in 2010, 56 per cent of which was done in cash and the rest via electronic funds transfers (EFT) and credit or debit cards, according to MasterCard International and Euromonitor.
In 2015, consumers are expected to spend US$48 trillion on goods and services, but 46 per cent of that amount will be paid for using cash.
"EFT has been growing at about 10 per cent per year, cash has been growing at less than 2 per cent and total [expenditure] has been growing at about 5 per cent to 6 per cent, so cash is losing share every year to these cashless forms of payments," Douglass says.
The transition to paying for products and services by using cards and EFT has been happening for a long time, but it is likely to accelerate thanks to the smartphone revolution.
"We have a strong view that your smartphones, your iPhones and your Android phones and possibly your Nokia phones . are going to enable the world to pay for transactions by simply showing your phone and within your phone you will be able to have all your royalty cards stored," Douglass says.
Within 20 years, he says 60 per cent to 80 per cent of all transactions may be cashless.
"So this means this whole payments industry could grow at 7 per cent to 9 per cent," he says.
"We have about 14 per cent of the portfolio directly in payments through Visa, MasterCard, American Express and very importantly a business called PayPal, owned by eBay.
"If you think about the payments space, what are these companies? They are technology processing companies; they collect a royalty over sales. So if you get inflation in the world, this is a royalty over inflation and growth higher than GDP (gross domestic product)."
The Magellan Global Fund is also favouring Google, the owner of the world's biggest search engine, because the company is embarking on a strategy that would allow consumers to search for all forms of commerce through a smartphone.
"They want you to talk into your phone in any street in the world and be able say 'restaurants nearby' and they want to make sure that every restaurant, in every street in every city in every country has listed themselves with Google," Douglass says.
"And when you have that you will have all the listings of all restaurants, you will know what type of restaurants they are, you will be able to click to call if you want to make a reservation and then you can push Google Maps and it will give you directions to where that restaurant is, and that won't be just restaurants; it will be all forms of commerce.
"This is the holy grail for advertisers and for Google and they haven't even started yet."
While managers often spruik the idea that Australian investors can access the Asia and emerging markets growth story through multinational conglomerates, Eight Investment Partners chief investment officer Kerry Series reckons investors should go direct. "I think it's quite condescending to say that of the 21,000 listed companies across Asia-Pacific that you can't find good-quality companies with good management that are 100 per cent exposed to the Asian story," Series says.
"If you like the story, why do you want to own half of it and not the full story?"
He says market fundamentals are at an interesting point today because valuations have converged.
"Ten years ago developed markets traded at a substantial valuation premium to Asia and emerging markets in general, but we're at an interesting point today where valuations have converged because developed markets have de-rated and the emerging world has re-rated," he says.
"The question in my mind is what will happen in the period ahead? Will investors go back to investing in developed markets because the differential has closed?
"We think that seems unlikely given that Asian and emerging markets are going to experience higher growth than developed markets for structural reasons."
He says investors should be overweight to Asia specifically because the region will be the growth driver for emerging markets and also present the best investment opportunities.
The firm is favouring mining companies and Chinese domestic consumption and holds names such as OSIM and Huiyin Household Appliances.
"OSIM manufactures and sells massage chairs and have also set up their own franchise network to distribute vitamin products. We expect demand for these products to be very strong," Series says.
"Huiyin Household Appliances is an appliance maker that operates in tier three and four cities in China, which are areas that are seeing the fastest income growth.
"A lot of property development is occurring in these places, so we see strong demand for household appliances. It is also very difficult to set up distribution in these places, so this company is well placed."
While market commentators have laid out their concerns over inflation in Asia in recent times, he says inflation rates across the region have been no worse than in previous cycles.
"I think we are approaching a point in time where inflation is actually about to roll over and start to fall because policy has been tightened," he says.
"It looks to me like the authorities across Asia have done exactly the right thing. They have been a lot more proactive than authorities in developed economies were in the last economic boom and I think consequently growth will slow a little and inflation will soften."
