Value stocks may be set to rebound
Time is now to buy diamonds in rough
Buying so-called value stocks at bargain-basement prices has netted sub-par returns for more than a decade. The big winners have been popular growth stocks such as Alphabet, Amazon and Netflix that keep going up despite selling at much higher valuations.
But don’t count out the market’s diamonds in the rough just yet, Wall Street fund managers and investment strategists say. These ignored stocks could be poised to play catchup.
Value investing is buying stocks that are trading at low valuations relative to earnings, book value and sales. Buying stocks at lower prices is a good indicator that they’ll deliver higher future returns than more expensive stocks, says Wes Crill, senior researcher and VP at Dimensional Fund Advisors.
“This is one of the best times in history to buy value relative to growth,” adds Dave Iben, chief investment officer at Kopernik Global Investors. “Value is buying things for less than they’re worth. You’re really getting bargains on companies people don’t like. Now is the time to take advantage.”
Value stocks he likes include China Telecom, General Electric (which once was the most valuable company in the U.S. but has fallen on tough times), and natural gas company Range Resources.
“A lot of value stocks are selling at half of what we think they’re worth,” Iben says. “If we’re right,” Iben says, “they will double.”
Buying stocks at lower prices is a good indicator that they’ll deliver higher future returns than more expensive stocks, says Wes Crill, VP at Dimensional Fund Advisors.
Value stocks can sell at steep discounts for a variety of reasons. They can go on sale because of a short-term business hiccup, a public relations crisis, a CEO change, movements in interest rates, economic slowdowns, or overly pessimistic investors pricing them too low. Value sectors include financials, health care and industrials.
Part of the current appeal of beaten-down value stocks is that they’re now cheaper compared with their growth counterparts than they’ve been in a very long time. Value stocks, as measured by their price-to-book ratio (i.e. what the company would be worth if liquidated), are trading at their lowest valuations relative to growth in at least 20 years, according to Bank of America (BofA). “Value is inexpensive,” says Jill Carey Hall, an equity strategist at BofA.
The best time to buy value stocks is during a recession, says Andrew Slimmon, managing director at Morgan Stanley Investment Management. Prices get so “extraordinarily cheap” in bad times that it creates a great buying opportunity.
“No one wants to buy industrials, energy stocks, airlines or cruise ships during a recession,” Slimmon says. “But that’s when you make the biggest returns. You can have doubles and triples in many value stocks.”
Another sign of just how much value stocks – such as banks like JPMorgan, communications companies like Verizon and health care plays like Johnson & Johnson – have lagged growth is by comparing performance.
From the end of 2006 to the end of 2019, the latest period in which value has fared worse than growth, the Vanguard Value
Index Fund posted a return of 76%, vs. a 215% gain for the Vanguard Growth Index Fund. This year through June 26, despite a brief period of eye-popping returns for value after the recent market bottom, the value index is down 19% and the growth index is up 7.5%.
But just because value stocks are selling at blue-light special prices doesn’t mean they have to go up. To start moving higher, a catalyst or bullish narrative is required.
Some catalysts that have spurred value stocks higher in the past include:
Recession gives way to recovery
Some of the best stretches of performance for value stocks going back to the 1930s have come when the economy was emerging from recession, BofA data show.
“When profit growth is accelerating and earnings are becoming more abundant, investors don’t need to pay up for expensive growth stocks,” says
BofA’s Hall. “That’s when value tends to work well.”
Highfliers come back to earth
Just like the “Nifty Fifty” large-cap stocks that nobody thought could ever go down in the late 1960s and early ’70s, or the overloved dot-com stocks that crashed in early 2000, a shift to value stocks can occur when growth stocks get too popular and too expensive, and investors dump them in favor of cheap stocks, Iben says.
Value gets too cheap to ignore
For a long time, there wasn’t enough value in value stocks to buy them. But that changed in the bear market this spring, says Christopher Harvey, head of equity strategy at Wells Fargo Securities. “Prior to the selloff in March, we hadn’t seen value stocks selling (so cheap relative to) book value in 10plus years,” he says.