September was the worst month of the year for global equities, with a 7.2% slide in the Morningstar Global Markets Index. This development has increased the abundance of stocks deemed undervalued on Morningstar's star rating scale. 

The star rating has a distinct advantage over traditional Price/Fair Value calculations in that it incorporates a level of uncertainty in its estimations. Two companies can have a very similar Price/Fair Value, but that does not necessarily translate into the same Morningstar rating. 

Therefore, looking at the number of stocks getting four and five stars (stocks considered as a buy—in green in the chart below) and the number of stocks with one or two stars (considered as a sell—in red) offers a better clue as to whether the stock market is cheap or expensive.

In September, the percentage of stocks with 4 or 5 stars across our entire database of 1,461 companies jumped sharply from 52% to 67%. That 67% level was last reached in March 2020, which means that worldwide share prices are about as cheap now as they were in the worst days of the COVID crisis.

The percentage of overvalued stocks with 1 or 2 stars is also very similar to that of March 2020. At that time the percentage was 9%, compared to 8% now. 

The Australian case

In contrast to global stocks, the undervaluation for Australian stocks has not reached pandemic-trough levels in September. The percentage of 4 and 5 stars stocks stood at 55% last month compared to 67% at the end of March 2020.

Distribution by sector

Communication Services is the sector with the highest percentage of 4 and 5 stars stocks, suggesting it is currently the cheapest basket, while Defensive Consumer is the sector with the highest percentage of 1 or 2 star companies, making it the most expensive by this metric.

It should be noted that market capitalization is not taken into account in these calculations, whereas in sector funds or ETFs, larger companies tend to have a higher weighting.

While consumer defensive stocks lead the pack of the most-overvalued sectors, the next three most-overvalued industries are economically sensitive.