A little over a year ago, I wrote that value stocks were coming back. After trailing growth stocks badly for more than a decade, value beat growth in 2022 and appeared in the ascendancy.
But I jumped the gun. Over the past 12 months, the S&P 500 Value index performed well, returning 15.3%, but the S&P 500 Growth index did far better, gaining 32.5%. The Russell 1000 Value index, which is calculated in a different way and includes midsize stocks, lagged the Russell 1000 Growth index by even more, returning 13.1% to Growth’s 33.5%. (Returns and other data are as of June 30; securities I like are in bold.)
I am not giving up. Of course, timing the market is impossible, but value and growth move in cycles, and there’s a good case that it is finally value’s turn again.
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Value stocks are those out of favor with investors, as evidenced by lower valuations. Usually, that means profit growth may be consistent but far from spectacular. S&P uses three metrics for identifying value: lower ratios of a stock’s price to its earnings (P/E), book value (P/B) and sales (P/S). Russell pegs value stocks as having lower current P/B ratios, as well as slower book, earnings and sales growth over the past five years and lagging sales projections for the next two years.
Value led growth in the 1980s, and growth dominated in the 1990s. With the collapse of the tech bubble in 2000, value gained the upper hand for seven years, then passed the torch back to growth. Over the past decade, the S&P Growth index beat the Value index by an average of more than five points per year. That’s a remarkable performance, especially when you consider 2022: The Growth index lost 29.4% and the Value index dropped just 5.2%.
It's all about technology stocks
Large-capitalization growth stocks have done well lately for two big reasons: first, the spectacular climb of technology stocks, which represent 63% of the assets of the S&P 500 Growth index and just 13% of the Value index; and second, low interest rates, which tend to favor fast-growing companies that take on debt to finance capital investments and research and development.
BofA Securities issued a report in June that stated, “After two decades of steady underperformance, U.S. value may outperform growth again.” The report referred to a seminar 50 years ago called “Renaissance of Value,” led by Benjamin Graham, the polymath investment guru who was Warren Buffett’s mentor. It is time, wrote BofA analysts, for another renaissance.
The impending rebirth of value, they wrote, makes sense either in the bull case (with the earnings of value stocks in long-neglected sectors playing catch-up) or in the bear case (with tech revenues hurt by a “hard landing” after the current round of Federal Reserve rate hikes and value stocks doing comparatively better than growth stocks falling from a greater height).
Finally, wrote the analysts, “the macro shift from a ‘2% world to a 5% world’ [a reference to market interest rates] supports value stocks.” With higher rates, value should outperform growth by 5 percentage points annually, if history is a guide.
I find this reasoning compelling, and I have two other arguments for value. The first is an instinct that it’s time for a change. Growth has been king for nearly two decades. That’s enough. Trees don’t grow to the moon. My second argument is far more convincing. It is that over the longer term, value has beaten growth handily, and there is no reason this trend won’t continue.
Growth is good. Bargains are better.
Why does value beat growth? Because cheap beats expensive. Investors often shun value stocks because they get bored with steady performance and need excitement. They want to climb aboard the new, hot thing — not the old, tried-and-true one.
Value stocks thus get “mispriced” on the low side, just as growth stocks get bid up beyond their true worth. The proof is in the history. Over the past century, value has beaten growth by an annual average of more than four percentage points — a huge margin in the world of investing. What’s more, although investors usually get higher returns for taking on more risk, in the case of value stocks, the risk is actually about 10% lower, based on standard deviation, a measure of volatility.
Right now, there’s a chasm between value and growth valuations. For example, S&P Dow Jones Indices reports that the average P/E, based on analysts’ earnings projections, for the S&P 500 Value index is 16.3; for the growth index, it’s 27.5. The average P/B ratio for value is 2.7; for growth, it’s 9.6. The S&P 500 Value index has a dividend yield of 2.3%; for growth, it’s 0.7%. (Higher yields are an indicator of value.)
Because stocks often shift between value and growth categories, the best way to invest in value is through an exchange-traded fund linked to an index. The best choices are iShares S&P Value ETF (IVE, $182) and Vanguard S&P 500 Value (VOOV, $176). For a portfolio that includes smaller stocks and has an even lower proportion of tech shares, consider iShares Russell 1000 Value (IWD, $174) and Vanguard Russell 1000 Value (VONV, $77). All of these ETFs carry expense ratios of less than 0.2%.
In its recent deep dive on value, BofA recommended three sectors as especially attractive: utilities, energy and banks. I completely agree. Utilities and energy have risen in price but still have low valuations, and they are primed for rising revenues as demand for electricity increases (in part because of the need for powering artificial intelligence computing and electric vehicles) and there are roadblocks — many of them political — to increasing supply.
You can buy utility stocks through ETFs such as Utilities Select Sector SPDR (XLU, $68) and Fidelity MSCI Utilities Index (FUTY, $44); energy through Energy Select Sector SPDR (XLE, $91) and Van Eck Oil Services (OIH, $316); and banks through Invesco KBW Bank (KBWB, $54) and SPDR S&P Bank (KBE, $46).
You can also look for individual stocks offering good value. There are few greater pleasures in investing than successfully backing a company that “Mr. Market” ignores or even hates. Here are some candidates: ExxonMobil (XOM, $115), with a forward P/E of 12 and a dividend yield of 3.3%; JPMorgan Chase (JPM, $202), with a P/E of 13 and a yield of 2.3%; Deere (DE, $374), with a P/E of 15 and a yield of 1.6%; and Johnson & Johnson (JNJ, $146), with a P/E of 14 and a yield of 3.4%. All four of the stocks are components of the S&P 500 Value index.
Just remember that value investing requires conviction and a long time horizon. In his remarks at the value renaissance seminar 50 years ago, Benjamin Graham said it best: “If you believe — as I have always believed — that the value approach is inherently sound, workable and profitable, then devote yourself to that principle. Stick to it, and don’t be led astray by Wall Street’s fashions, its illusions and its constant chase after the fast dollar.”
James K. Glassman chairs Glassman Advisory, a public-affairs consulting firm. He does not write about his clients. His most recent book is Safety Net: The Strategy for De-Risking Your Investments in a Time of Turbulence. He owns none of the securities mentioned here. You can reach him at JKGlassman@gmail.com.
Note: This item first appeared in Kiplinger Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here.
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