Value plays likely to be few and far be­tween for fore­see­able fu­ture

The Globe and Mail (Alberta Edition) - - GLOBE INVESTOR - JOHN REESE

Some prom­i­nent pro­fes­sional in­vestors have been talk­ing about the dif­fi­culty of find­ing value stocks in a mar­ket that seems to go nowhere but up.

Even War­ren Buf­fett’s Berk­shire Hathaway is sit­ting on $100-bil­lion (U.S.) of cash look­ing for places to in­vest. Af­ter los­ing out on a hot trade in the en­ergy sec­tor this sum­mer, his big­gest deal so far this fall has been to take a pri­vate stake in Pi­lot Fly­ing J, the largest truck stop op­er­a­tor in the United States.

The deal isn’t go­ing to go far to solve the bil­lion­aire’s dilemma. He has so much cash to put to work he needs a big trans­ac­tion or two to re­ally move the num­bers.

But Mr. Buf­fett is a value in­vestor and the fact that even he is look­ing in ev­ery nook and cranny for a big idea means the av­er­age in­vestor is prob­a­bly also work­ing ex­tra hard these days to find value plays.

This is likely to con­tinue for the fore­see­able fu­ture. There are a num­ber of con­di­tions that many be­lieve sup­port the mar­ket’s high val­u­a­tion, in­clud­ing broad global eco­nomic growth and strong cor­po­rate earn­ings. Com­pa­nies are flush with cash to in­vest or re­turn to share­hold­ers in the form of buy­backs and div­i­dends. Bonds, at his­tor­i­cally low yields, are sim­ply less at­trac­tive than stocks.

At such times as these, in­vest­ing for the long term means div­ing in even when things may look rel­a­tively ex­pen­sive on the sur­face. Mar­ket tim­ing is dif­fi­cult and haz­ardous. Gen­er­ally speak­ing, if you find a stock in a well-run com­pany and the shares trade be­low your buy price for a while, things will even­tu­ally take care of them­selves.

The trick is in find­ing these stocks. In a let­ter to share­hold­ers ear­lier this year, Mr. Buf­fett wrote that he and his Berk­shire vice-chair­man, Char­lie Munger, have no magic for­mula ex­cept to “dream big and to be pre­pared men­tally and fi­nan­cially to act fast when op­por­tu­ni­ties present them­selves.”

Al­though it has sold off a bit in re­cent days, the Stan­dard & Poor’s 500 is still trad­ing above its 50- and 100-day av­er­age lev­els, and the story of the year con­tin­ues to be in­for­ma­tion tech­nol­ogy, a sec­tor that makes up more than one-fifth of the in­dex and has con­trib­uted much of its 15-per-cent gain this year.

As a sec­tor, IT has gained 36 per cent this year and it’s hard to ig­nore the daz­zling re­turns. Shares of Net­flix are up 60 per cent this year; Ama­zon, Ap­ple and Face­book are up more than 50 per cent; and Google par­ent Al­pha­bet is up 30 per cent.

Given the way it has been act­ing over the past year, Berk­shire seems to see Ap­ple as a value stock in a hot sec­tor. It has bought Ap­ple shares over sev­eral quar­ters – even dur­ing this year-long up­swing. That means Mr. Buf­fett is look­ing at Ap­ple’s mar­ket-dom­i­nat­ing po­si­tion and brand strength and reck­on­ing tak­ing a stake now will pay off big a decade down the road, re­gard­less of whether it makes some tem­po­rary dips along the way and re­gard­less of its seem­ingly high price today.

Tech­nol­ogy isn’t the only strong area of the U.S. mar­ket. Stocks in the ma­te­ri­als and health-care sec­tors are also strong this year, boosted by the prom­ise of in­fra­struc­ture spend­ing, the po­ten­tial for merg­ers and the pos­si­bil­ity of big reg­u­la­tory changes (though noth­ing on that last front, yet), and yet there are still some stocks lag­ging the rest.

Value in­vest­ing hasn’t been the most pop­u­lar strat­egy, track­ing slightly be­low the mar­ket so far in 2017, al­though over the long term it has proved to be a win­ning for­mula. Validea’s Ben Gra­ham-based value port­fo­lio has re­turned 416 per cent since 2003 com­pared with 158 per cent for the S&P 500.

Here are three stocks, one from each of the S&P 500’s three hottest sec­tors, that could pro­vide some value for stock pick­ers.

› Mi­cron Tech­nol­ogy Inc. – De­spite the fact that this chip maker’s stock has dou­bled this year, there could still be room for gains on ex­pected strong de­mand for mem­ory chips. Its for­ward 12-month price-to-earn­ings ra­tio is at­trac­tive, less than half that of ri­val In­tel Corp. It falls into our strat­egy track­ing the in­vest­ing style of famed Fi­delity Mag­el­lan Fund man­ager Peter Lynch, which would point to long-term sales growth of 14.9 per cent and a priceearn­ings-to-growth (PEG) ra­tio of 0.34.

› Uni­ver­sal For­est Prod­ucts Inc. –

Here’s an­other stock that has been hit­ting records on ex­pec­ta­tions that a pickup in con­struc­tion will mean a pickup in de­mand for its lum­ber prod­ucts. It fits into the model track­ing the style of James O’Shaugh­nessy, the well-known quant in­vestor and au­thor of What Works on Wall Street, with per­sis­tent earn­ings growth and a price-to-sales ra­tio of less than one, in­di­cat­ing it is still a bar­gain.

› United Ther­a­peu­tics Corp. – This biotech makes treat­ments for lung and other dis­eases. It fits a few mod­els, in­clud­ing the one that em­u­lates hedge fund man­ager and au­thor Joel Green­blatt, who looks at where stocks rank in earn­ings yield and re­turn on cap­i­tal. The com­pany ranks as the 10th best stock in the Green­blatt model’s over­all in­vestable uni­verse based on the com­bined earn­ing yield and ROC rank­ing. It also fits the Lynch model, which heav­ily weights the PEG ra­tio: With a PEG of 0.25, the stock is at­trac­tive based on the val­u­a­tion rel­a­tive to its growth rate.

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