The US has been one of the most prosperous regions for investors over the past decade or so, with its stock market offering access to a range of exciting companies taking on the world. Investors are right to have large exposure to the US but they need to keep an eye on valuations.

The Nasdaq 100 trades on 28 times forward earnings and the S&P 500 trades on 20 times forward earnings, according to data from Birinyi Associates. While these figures are not out of the ordinary when looking back over the past 20 years, they are still high enough to make stocks vulnerable to big falls upon the first sign of unwelcome news.

That is certainly a trend we have seen building over the past few months as multiple US-listed companies have experienced double-digit share price declines on negative news flow. With various companies talking about a slowdown in the pace of growth, investors might need to be on guard.

One solution is to tilt part of your US exposure in a portfolio towards a value-style fund. Fidelity American Special Situations (B89ST70) looks like an ideal candidate as it focuses on investing in companies with quality characteristics trading below what the fund managers believes to be their intrinsic value. Its portfolio traded on an average 14.1 times earnings as of 31 October 2023.

VALUE’S BIG COMEBACK

The value investing style was out of favour between 2009 and 2020 because of low economic growth, falling inflation expectations and low interest rates which meant investors were happy to pay a premium to buy shares in companies capable of delivering strong earnings growth in that environment.

The tables have turned in recent years thanks to inflation and interest rates going up. The MSCI World IMI Growth index has returned 14.9% since the start of 2021 whereas the MSCI World Value index has achieved 26.4%. Fidelity American Special Situations has done even better over the same period, returning 42.8%. The fund has a 0.86% ongoing charge.

LOOKING THROUGH NEAR-TERM ISSUES

US pharmaceuticals distributor McKesson (MCK:NYSE) is one of the fund’s biggest holdings. Despite facing significant headwinds centred around its alleged role in fuelling the US opioid epidemic, the shares have performed strongly over the past five years.

‘When we invested in McKesson it was under scrutiny because of the opioid crisis and perceived competitive threats from Amazon,’ explains portfolio manager Rosanna Burcheri. ‘(On the former) there were a huge number of lawsuits and the possibility of unlimited liability according to certain analysts.

‘The reality we’ve seen in the past, when you have these big legal cases, is that the company reaches a settlement. Yes, it’s a lot of money but the fact that you can put a number on that and run your valuation is what gave us the confidence to go ahead and invest.’

Burcheri says almost 90% of US prescription drugs flow through the distributor. Three companies dominate this industry and they have 95% market share combined. ‘I like this situation as it gives them high pricing power.’

SEEING VALUE WHERE OTHERS DON’T

FedEx (FDX:NYSE) also sits in the fund’s top five holdings and is another situation where the shares have faced a barrage of unwelcome news, yet the stock has eventually pushed higher.

September 2022 saw the package delivery giant issue a profit warning linked to a gloomy economic outlook, causing the share price to fall by 21%, the biggest one-day drop since it joined the stock market in 1978. By April 2023 it had made up the lost ground and the stock has risen further despite margins coming under pressure.

‘There is still a huge amount of value in the business. We have a new management team and the plan put in place makes sense. The company is going through a huge refresh of the aircraft fleet compared to competitors like UPS – it has the youngest fleet and is more efficient. There is a need to cut costs as the organisation had ballooned during the pandemic. Everyone was ordering goods so costs built up, which it is now trying to reset.’

Burcheri says there is an opportunity to combine the express and ground business, saying FedEx does not need two different trucks running around the same neighbourhood.

‘The market is underestimating the cash earnings power of FedEx,’ she adds. ‘The profitability and return on investment are still much below UPS which was always considered the gold standard in the industry and there is the potential of catching up.’

Elsewhere, Fidelity American Special Situations holds a stake in Google’s parent company Alphabet (GOOGL:NASDAQ). Burcheri believes the market is underestimating the franchise value of Google and that Alphabet has significant opportunities with cloud computing and its YouTube video platform.

PORTFOLIO CONTENDERS

Next up for the fund could be one or more investments in stocks caught up in the drama around weight-loss drugs.

The hype around companies selling these treatments has led investors to sell down positions in businesses they perceive to be losers from a weight-loss boom. Think snack companies, fizzy drink manufacturers and pharmaceutical groups providing treatments to illnesses caused by obesity such as heart disease and diabetes. Burcheri says she has spotted names now trading at levels rarely seen in her career.

The market has a habit of overreacting to perceived threats and there is no guarantee that weight-loss drug sales will match lofty expectations. Reports of unpleasant side-effects from these treatments could even make people hesitant about taking them.

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