After years of struggles, value stocks are expected to outperform. Here’s how to profit
Oh, those poor value stocks. They’ve been wallflowers for years, as trendy tech shares zoomed aloft. But even as the tech stars outshone them, Wall Street retains a soft spot for value strategies, which lately seem to be perking up. This provides an opening for opportunistic investors. For the past 10 years, growth has skunked value big-time. The iShares growth ETF rose 18.4% annually, versus 12.8% for value. Over the past five years, the contrast has been even starker: 22.6% versus 11.9%.
Value investing is a quest for tarnished gems, underappreciated stocks that the market will some day awaken to. Almost by definition, value investors are contrarians, going against the popular grain. Value stocks’ price/earnings (P/E) ratios, the standard affordability measure, tend to be low. So they can be scarfed up cheaply. Their often-rich dividends are an added enticement. (Growth stocks have surging revenues that propel their share prices and P/Es skyward, yet they rarely offer dividends.)
And in 2022, the tide may be turning, with many market watchers predicting that value should do slightly better than growth, because higher inflation and interest rates historically favor value, according to LPL Financial. Financial services, energy, and industrials are the value sectors that will benefit the most, says the investment firm.
That comeback may already have started. Since before the holidays, dormant value began to rally, as technology-heavy growth flagged amid talk of rising interest rates. Higher rates tend to sap the earnings power of tech stocks in years ahead. Thus far in 2022, the iShares S&P 500 Value (IVE) exchange-traded fund has advanced 1.2%, while its growth counterpart, iShares S&P 500 Growth (IVW), has lost 5.1%.
Sure, value has seen false dawns before. In late 2020 and early 2021, value stocks overall suddenly did better than growth, as rising optimism about the pandemic’s end emboldened investors to venture into the bargain bin. At the time, financial advisers began urging “rotation” for their clients into value and out of growth. But then the value spurt ebbed and those stocks stayed flat from May until recently.
Classically, value performs best in the beginning of an economic cycle, as previously sidelined money pours into solid, unflashy stocks that investors can trust. That’s what happened after the 2000 dotcom crash, when long-shunned old-time stalwarts became go-to investments. Value names like Procter & Gamble and Duke Energy rallied. The same value rebound followed the 2008–09 financial crisis.
That said, value’s advantage has narrowed over the years. Economists Eugene Fama and Kenneth French concluded that value handily outperformed growth from 1963 to 1991, by 4.3% annually, but later on, they found that value’s edge narrowed to 0.6%. No one is sure why the change took place. Some think the ascent of tech, with its extraordinary revenue escalation and burgeoning intangible assets—the worth of nonphysical things like data and operating systems, etc.—changed the picture.
The upshot is that investors in recent years have needed to be even more discerning about their value selections if they want to find incipient winners.
Value stocks to buy now
Value stocks fall mainly into two categories, defensive and cyclical. The defensive ones seldom go very far down in a recession, and also seldom rocket when times get better: consumer staples and utilities, for instance. The cyclicals are very sensitive to the economy and have a lot of upside once things improve. Energy and financials are prime examples.
The cyclicals are having a moment, owing to a still-strong economy that nonetheless is dogged by scarcities. These days, as the world hustles for fuel, energy stocks have done well (up 53% in 2021, and 11% year to date). Ditto for financials (ahead 32% last year, 5% this year), with interest rates on the rise, which is good for banks because they can charge more for loans.
A big beneficiary in the energy sector is Devon Energy (DVN), whose stock has almost doubled over the past 12 months, as revenue and earnings have shot ahead after a money-losing 2020. Operating cash flow for last year’s third quarter was up 46% over the second period. Devon is involved in oil and natural-gas drilling and exploration. The catalyst here is that crude prices leaped 57% over the past 12 months and gas climbed 65%.
Another unsung value play: Arizona public utility Pinnacle West Capital (PNW), whose stock is down almost 10% over the past 12 months to mid-January, partly due to an unfavorable rate ruling by regulators. The company still has commendable cash flow, serves an area with a swelling population, pays a healthy 5% dividend yield, and sports an inexpensive 14 P/E.
On the defensive side, a zest for consumer staples has pushed a number of such stocks out of their stodgy, rangebound existences. Tyson Foods (TSN), for instance, has enjoyed a 43% share bounce over the past 12 months. This marks a comeback from 2020, when Tyson and other meat-processing stocks were slammed during COVID’s early stages. Since then, revenue and profits have jumped as demand from homebound consumers has spurred hefty meat price increases.
The auto industry has been on a wild ride during the pandemic and these days suffers from shortages of chips. Even though BorgWarner (BWA) doesn’t make chips, its customers rely on them, thus Detroit’s orders for Borg parts have slowed. Off its May high, the stock still is ahead from a year ago. (The stock is on Bank of America’s top picks for 2022.)
While the early part of the COVID scourge tested its profitability, with the September-ending quarter’s earnings per share down some 25% from the comparable year-before quarter, the company’s future looks pretty good. Borg has a robust and growing electric-vehicle operation, and the popularity of sport utility vehicles plays to its strengths. So does its product line that aids in reducing emissions.
A few pharma firms’ stocks have benefited from their work combating COVID. Chiefly, Pfizer, whose stock is up by half over the past 12 months. Bristol-Myers Squibb (BMY), which unlike Pfizer has no COVID vaccine, is not in that blessed situation. Its share price has wobbled all over the place and now is pretty much where it started 12 months ago. Some analysts blame the drug-pricing rules in President Joe Biden’s social-spending initiative, although that measure seems unlikely to pass. Others point to the expiration of exclusivity on key drugs like multiple myeloma treatment Revlimid this year. But the company’s fundamentals are solid, with revenue and earnings expected to log good increases, and several new drugs are soon to launch. Plus it has a nice dividend, yielding 3.3%. (Bristol is on Goldman Sachs’ list of best value plays for this year.)
The entertainment industry has taken a pounding from the pandemic, and Walt Disney (DIS) is a prominent victim. After cratering in early 2020, the stock headed skyward again—only to founder with the onset of the Delta and Omicron variants. For the fiscal year ending in October, the company did manage to return to profitability, but earnings fell shy of analysts’ expectations. (Disney is on BofA’s list.)
Theme parks are still open, yet operating at a reduced level. The Disney+ streaming service, which got off to a boffo start, has run into a subscriber growth slowdown. Still, with its storied brand, bounteous attractions, not to mention an ambitious plan to conquer the metaverse, Disney should be fine in time, analysts say. All it will take for the House of Mouse’s renewal is for the coronavirus to finally retreat into its rathole and stay there.
Value funds and indexes
Even if you aren’t prepared to go all-in on value, many advisers contend that a dollop of value in portfolios makes sense. A more balanced portfolio is better prepared for the market’s ups and downs. A wise course is “to find opportunities in both growth and value styles,” writes LPL analyst Scott Brown in a research note.
Mutual funds have a separate “blend” category, which mixes both value and growth. Performance tends to fall in between the two other styles. In a Morningstar study encompassing 2021’s first 11 months, when growth and value traded places in performance terms, blend funds actually did better than the other two. One top blend mutual fund is Fidelity Dividend Growth, which sports four stars from Morningstar. It has a good long-term record and last year beat the S&P 500 by a full percentage point.
On the other hand, if the rest of your portfolio is already growth-heavy and you’re just looking to beef up the value quotient, many advisers like the SPDR Portfolio S&P 500 Value ETF (SPYV). It sports a very low expense ratio of 0.04%, meaning your returns are not shrunken by fat fees.
The fund aims to follow the S&P 500 value index. The downside is that the ETF suffers when value in general does. In turbulent 2020, the fund eked out a mere 1.1% increase, while the overall market zoomed over 20%. Such is the lot of the value investor, ever hopeful for turnarounds.
When things go right, though, that long-suffering contrarian investor can afford to be smug. James Grant, founder of the influential newsletter Grant’s Interest Rate Observer, once summed up the lot of value investors this way: “Successful investing is about having people agree with you…later.”
Never miss a story: Follow your favorite topics and authors to get a personalized email with the journalism that matters most to you.