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