The major lesson from last year’s volatility is this: You just can no longer buy and hold—you have to be ready to move when the market dictates it.
That doesn’t mean trading in and out of stocks daily, but it does require the willingness and flexibility to make moves when the trend changes. Like now.
We were in a growth stock mode for the last few years, and value investors suffered. But now, it appears that the trend may be changing, and value stocks just might be coming back in vogue.
Here’s what the returns for growth stocks vs. value stocks look like, last year, and year-to-date 2019:
As you know, growth investors buy stocks whose earnings and forecasted future earnings are growing at an above average rate. They are looking for swift acceleration, and that strategy works really well when the economy and stock markets are booming. Yet, when uncertainty reigns, investors in growth stocks tend to get a bit skittish.
The political climate has become marked by persistent challenges in the last couple of years; interest rates have been on the rise (some say, too quickly); and both have caused significant market volatility. So, it’s no real surprise that some investors are retreating into more conservative, value stocks.
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Now, don’t get me wrong. I love a very diversified portfolio—at all times. But once in a while, it makes sense to rebalance, and tilt your holdings toward a different strategy. And that time may be now. So, let’s take a closer look at value investing.
How Value Investing Works
Value investing essentially refers to a strategy of buying shares that are underpriced or overpriced relative to their true value, providing investors with great opportunities to ‘buy low.’
Value investors believe that stocks move sometimes simply due to overreactions to good and bad news (or investor irrationality), and not because of their inherent fundamentals. For example, an earnings report that is perceived by the market to be less than expected can cause a solid, fundamentally strong company’s shares to plummet—many times, temporarily. And a company that beats analysts’ earnings estimates can also decline, if revenues or forward guidance didn’t meet expectations. Those movements provide opportunities to buy in when the stocks are discounted.
Many growth investors feel that value stocks are boring. And sure, some of them are. You don’t usually see breakneck moves in value stocks, but in the right climate, they can give you steady growth—and in many cases, nice cash flow via dividends.
The characteristics that generally define value stocks are:
- A low P/E, which should be in the bottom 10% of its peers. P/E is a calculation of four quarters of the company’s earnings, divided by its current stock price.
- A Price to Earnings Growth Ratio (PEG), less than one. A PEG is the P/E divided by the earnings growth rate over the same period of time.
- Reasonable debt levels.
- Trading at a share price less than tangible book value. Tangible book value is equal to tangible assets divided by total number of shares outstanding. Tangible assets are assets that you can physically see and touch, such as buildings, machinery, cash and inventory—not patents or goodwill, or other assets that cannot be liquidated for cash.
Now, just because a stock meets the above criteria, doesn’t mean it’s a slam-dunk. Consider this:
- Value is in the eye of the beholder. With the same information, two investors may estimate the value of a company very differently. Some consider only current earnings and assets, without taking growth into account. Others calculate forecasted growth and the cash flow it will generate.
- Just because a company is cheaply priced doesn’t mean it’s undervalued. The stock may be trading cheaply because it’s a dog. Consequently, further analysis is required.
So, when I started searching for value stocks for 2019, I began with my value parameters, and then further narrowed the field by looking at other characteristics such as investor interest in the stock (insider, institutional, and retail), and a few other technical factors to determine if this may be the right time to step in.
I came up with three value stocks that look interesting.
Three Little-Known Value Stocks
The first is Virtu Financial, Inc. (VIRT), a company that provides market making and liquidity services through its proprietary, multi-asset, and multi-currency technology platform to the financial markets worldwide. Virtu has a P/E of 12.07 and is rated ‘Buy’ by consensus. Its shares have been recently upgraded to ‘Buy’ at Goldman Sachs, and the company beat its earnings estimates by a penny last quarter.
Next, is Ichor Holdings, Ltd. (ICHR), which makes fluid (gas and chemical) delivery subsystems and components for semiconductor capital equipment in the United States, the United Kingdom, Singapore, Malaysia, and South Korea. Coverage of the shares was just initiated at Needham; its EPS forecasts have been raised by three analysts recently; and the company also beat estimates by $0.01 last quarter. The shares trade at a P/E of 6.51.
And lastly, is Olin Corporation (OLN). It manufactures and distributes chemical products in the United States and internationally. It operates through three segments: Chlor Alkali Products and Vinyls; Epoxy; and Winchester. The shares are trading at a P/E of 5.02. Olin beat analysts’ EPS estimates by $0.07 last quarter, is rated ‘Buy’ by consensus, and coverage of the shares were recently initiated at Stifel Nicolaus with a ‘Buy’ rating.
As I said, these companies look interesting, are trading a low valuations, and are seeing earnings growth and some Wall Street attention. But, as always, run these value stocks through your own vetting system to make sure they fit with your ultimate strategy and goals.
Nancy Zambell, Editor of Wall Street’s Best Investments, has spent 30 years helping investors navigate the minefields of the financial industry. Nancy scours more than 200 advisories and research reports to select the top recommendations, which she collects for you in this easy-to-read digest.Learn More