Value stocks are not just big companies are not necessarily companies with a strong recent track record. Rather value stocks are priced by the market below what their forward looking earnings should dictate. Value stocks are not always immediate winners. But do value stocks outperform over the long run? After all long term growth and dividends are typically why investors look to value stocks. Forbes published an interesting article about value stocks.
Value is not, never was and can never be just about low ratios. Anybody who sorts on the basis of P/E, Price/Sales, Price/Cash Flow etc. and simply buys stocks at the low end of the spectrum is asking for trouble. They may not always get smacked – Lady Luck can accommodate bad ideas for a long time periods. But when the going gets tough, Lady Luck tends to get going; away, far away, from our portfolios.
Forbes refers to the Dividend Discount Model used to equate the ideal fair price to dividend divided by the difference between required return and growth.
P = D/(R-G)
This is similar to calculating intrinsic stock value. The key to either approach is to routinely use it and to develop the necessary skill of anticipating growth. If you learn to do this right your value stocks will tend to outperform and if you neglect this approach your portfolio will suffer.
We often mention Warren Buffett, the famous investor and third richest man in the world, on these pages. Buffett says that he tends to avoid tech stocks because the tech world changes so rapidly that it is hard to accurately predict sustained growth and thus sustained stock price appreciation. He notes that it is a lot easier to anticipate the popularity of a bottle of Coca Cola or a Snickers bar ten or twenty years from now than the price of Apple or Microsoft. Some were surprised that Buffett investing in IBM but IBM has become more of a business service company over the years that that business is easier to predict. Do value stocks in Buffett’s portfolio outperform? IBM has not done all that well but overall if you had invested years ago with Buffett’s Berkshire Hathaway company you would be filthy rich today!
When to Invest and When to Expect Profits
When the market is heading down is commonly the time to search for value to stocks and when the market heads up and gets overpriced is the time to wait. The stocks mentioned in Forbes as value stocks that are working are AFLAC, Discover Financial Services, Eaton Corp, Ford Motor, Lam Research, PVH, Regions Financial, SunTrust Banks, Tyson Foods and Unum Group.
Timing stock investments can be tricky. Novice investors get excited and don’t want to miss out on profits in a bull market. Thus they buy too quickly and don’t assess intrinsic stock value. The same investors wait until a stock bottoms out to sell in a bear market. Value stocks do outperform but investors need to evaluate stocks for price and anticipated future earnings. A bit of good advice came from Jim Cramer years ago when he told investors to keep no more than 5 stocks in their portfolio because they needed to continually evaluate to see if they should buy, sell or hold.