The Current Stock Market
The current stock market is looking a lot healthier than it did a month ago or two months ago. In fact, since the recent low point on February 11, 2016, the Dow Jones Industrial Average is up 10.0%, the Standard & Poor’s 500 Index has advanced 10.4%, and the Nasdaq Composite Index has climbed 11.3%.
Growth Stock Surge
During the past decade, growth stocks have ruled the roost, led by the so-called FANG stocks which include Facebook (FB), Amazon (AMZN), Netflix (NFLX) and Google (GOOG). As illustrated in the chart below, the Russell 1000 Growth Index has soared 85.2%, well ahead of its counterpart, the Russell 1000 Value Index, which has managed to advance only 29.2%.
Similarly, growth stocks have outperformed value stocks during the past 5-year, 2-year, and 1-year periods. Only during the latest 1-month, 2-month and 3-month periods has value outperformed growth. So why am I optimistic about a resurgence in value stocks?
Growth stocks have outperformed value stocks since 2000, one of the longest periods of outperformance. The huge difference between growth and value gains is the largest ever recorded, but the wide outperformance enjoyed by growth stocks will end at some point, and now might be the turning point where value stocks develop a winning streak of their own.
Growth stock valuations are stretched to the limit while value stocks are too inexpensive to ignore. The Russell 1000 Growth Index sports a lofty P/E (price divided by earnings per share) of 20.9 compared to the Value Index’s 15.8 P/E. The divergence in the P/BV (price divided by book value per share) is even wider: 5.19 for growth and 1.74 for value. Value stocks, as usual, provide a higher dividend yield currently at 2.38% versus 1.47% for growth stocks. As I mentioned, value stocks are totally neglected and due for a comeback.
Previous periods of growth outperformance, including the Nifty Fifty market of 1966-73 and the technology bubble of 1998-99, were followed by strong periods for value investing, including seven straight years of value outperformance from 2000 through 2006.
“Momentum (growth) stocks trade at an extreme premium to value stocks, with the valuation spread the highest since 1980, except for during the tech bubble,” JPMorgan strategist Dubravko Lakos-Bujas wrote recently.
Rapidly increasing sales and earnings gains in the technology and healthcare sectors have bolstered the performance of the Russell 1000 Growth Index, whereas sagging sales and earnings in the financial, industrial, retailing and energy sectors have held back performance in value stocks.
10 Undervalued Gems
The attraction of investing in stocks with rapidly increasing sales and earnings has lured the majority of investors into growth stocks. In 2016, though, undervalued bargains in value stocks are gaining attention. After a long period of disfavor, value investing could be on the verge of a multiyear comeback, but investing in value stocks will require patience.
There are hundreds of undervalued stocks in the market today. I have listed 10 high-quality companies that have been beaten up badly, but will likely recover during the next 12 months.
All 10 of the stocks in my list are rated as undervalued by Standard & Poor’s, and each stock is rated above average quality by S&P.
Each stock is selling at a reasonable price to current earnings ratio, and all 10 stocks pay attractive dividends. Finally, all 10 companies are expected to report higher sales and earnings for the next 12 months.
“There are really good, well-run companies, attractively priced,” says Kevin Toney, co-manager of the American Century Equity Income Fund.
You can easily find these undervalued companies and learn about them in my Cabot Benjamin Graham Value Investor.
Until next time, be kind and friendly to everyone you meet.
J. Royden Ward
Chief Analyst, Cabot Benjamin Graham Value Investor