There are lots of ways you can narrow down the universe of potential stock investments. Start with a list of all publicly traded companies. There are only about 3,700 that are traded on an exchange and another 15,000 or so smaller companies that trade over-the-counter. From there, you may segment companies by size (small cap vs. large cap), by sector (e.g., financials, utilities, consumer discretionary), or by industry (there are over 100).
One of the most common ways to segment any list of stocks is: Value stocks vs. Growth stocks. Growth companies are the companies of the future (e.g., Facebook, Netflix, Tesla). They are fast-growing, exciting, and typically expensive. Value investors, on the other hand, are interested in the “here and now.” What is on sale today? These are the tried and true companies that have been around for a few decades (Bank of America, Proctor & Gamble, GE). Value companies may not be setting the world on fire, but … their price is right. Some stock pickers and mutual funds only invest in value stocks, and others only invest in growth.
Many investors prefer value for the following reasons:
- Historically higher returns for the level of risk
- Easier to analyze
- Less potential for surprises
- Higher and more consistent dividends
When growth stocks are hot…they’re hot!
There is only one thing I don’t like about value stocks … they have under-performed growth for nine consecutive years! This under-performance has made some value managers and their clients downright grumpy. The Russell 1000 Value Index under-performed the Russell 1000 Growth index by nine percentage points in 2015. At some point, growth stocks get too expensive and value stocks too cheap to ignore. Is that time upon us?
Growth stocks crushed value from 1966-1973 and then the roles reversed. Growth again significantly outperformed in the 1990s, only to be beaten by value stocks every year from 2000-2006. Growth has been the winner for again for the past nine years (2007 – 2016)
Here are a couple current examples of value stocks?
Here are a couple of examples of seemingly compelling value investments: General Motors (GM) – In this low yield environment, General Motors pays investors a juicy dividend of 4.6% and is trading at only 5.4 times earnings compared to an industry average of 9.6 times. The overall S&P 500 is at just over 17 times. There is concern about whether GM can continue the peak sales levels it has achieved over the past couple of years, and the slowdown in China has kept a lid on the stock. Nevertheless, China’s middle class continues to grow, and we believe GM will be a benefactor. The stock is currently trading at $31.87, but Morningstar has a fair value estimate of $48.00.
Another example of compelling value is the entire “Financials” sector. Financials presently have the most attractive valuations. Many investors are likely to be well-served in an ETF that mirrors the entire financial sector, although we prefer the ones that have minimal exposure to Real Estate Investment Trusts. We also like some individual companies in the sector such as JP Morgan Chase (JPM) – Chase was one of the few financials that navigated the financial crisis amazingly well. JPM has a pristine balance sheet, and any rise in rates over the coming year will significantly improve Net Interest Margins and add to profits. As a further sign of confidence, CEO Jamie Dimon put his money where his mouth was, buying more than $25 million in JPM stock for his personal account. JPM pays a generous dividend of nearly 3%.
Before you get too confident about value stocks, keep in mind that financials make up a big component of value indexes. Financials need to do well in order for the overall index to do well. Two things will drive Financials: 1) a strengthening economy, and 2) rising interest rates. Neither of those are a sure thing, but with healthy dividends in stocks like GM and JPM, you are being paid to wait for valuations to catch up.
A balanced portfolio containing growth and value stocks it typically the best way to generate consistent returns.
DISCLOSURE: The stocks mentioned in this article are not a recommendation but rather a starting point to do your own research. Please consult your investment advisor about whether the securities mentioned or value investing is an appropriate strategy for you.