John Reese is chief executive officer of Validea.com and Validea Capital, the manager of an actively managed ETF. Globe Investor has a distribution agreement with Validea.ca, a premium Canadian stock screen service.
So far in 2017, there is a huge divergence between the performance of growth and value stocks. The growth stock camp has been largely led by a handful of megacap technology names – Facebook, Apple, Amazon and Google parent Alphabet.
According to a recent Wall Street Journal story, the S&P 500 has added $1.7-trillion (U.S.) to its overall market capitalization in 2017, and those four technology behemoths have contributed $500-billion, or 30 per cent of the total gain based on their stocks' price appreciation. If you weren't invested in those names, you were probably left in the dust.
On the other side of the spectrum are value stocks, mostly names in energy, retail and financials, which are trading at a discount to the market based on earnings, book value, cash flow and other measures of value. As the same Wall Street Journal article points out, the S&P 500 value index, a large cap value benchmark, is up a mere 5.3 per cent through July 14 compared with its growth brethren, the S&P 500 growth index, which as returned 15.1 per cent.
But as Ben Graham once said, "price it what you pay, value is what you get." That is not to play down the value in many of the technology companies that are embedded in our daily lives, but if you look at the multiple of the S&P 500 growth index you see the portfolio is trading at 25.7 times earnings and more than 5.5 times the S&P 500's book value.
Compare this to the S&P 500 value index, which trades at 18.5 times earnings and a price-to-book of around 2, and it's clear that there is a big dichotomy in investors' minds about how they are viewing value and growth stocks now and in the future.
On the surface, it may be hard to see the value in today's market, especially because many see a tilt in the other direction. The current market multiple is above its historical average. The cyclically adjusted price-to-earnings (CAPE) or Shiller ratio, which uses 10 years' worth of earnings and is often cited at being semi-predictable of future returns, stands at 30.1 and is well above its historical average. Even the stock market-to-GDP ratio, which is a measure used by Warren Buffett, stands at a level near the 2007 high.
Looking at these measures, one would think the vast majority of stocks are overvalued, and the market is not cheap here by any means. But, remember, a big driver of that is the overweighting and outperformance of a handful of big tech stocks.
Investors may be warming up to the idea that there is value lurking out there. Using the two indexes mentioned above, value is up over growth in the past month.
Value-stock performance won't turn on a dime, because in the markets, a trend can last longer than investors expect. Growth-oriented tech stocks were market darlings in the 1990s, and it wasn't until the bear market of 2000 to 2002 that value got its turn. Value stocks and strategies then went on a seven-year period of massive outperformance over growth.
Investors with a long-term time horizon may consider strategically shifting, or tilting, some of their portfolio to value stocks at this point. But keep in mind, most value stocks look to have some type of fundamental problem or challenge – think retailers with online competition, energy names with commodity price volatility or financials with persistently low interest rates. These problems are all well-known, so the upside of value stocks comes when things aren't as bad as the market anticipates.
Using the stock selection models on Validea, I've looked for stocks that score highly through at least two of my deepest value strategies, which are based on great investors such as Ben Graham, Mr. Buffett and others. I further refined the list by removing stocks with a P/E of above 15 and a price-to-book above two. In an effort to try to find stocks below the radar, I also focused solely on smaller firms with market caps between $500-million and $2-billion.
United Natural Foods Inc. gets 100 per cent, based on my Ben Graham model. The stock, which trades well below its 52-week high, carries a P/E of 14.5 and a price-to-book of 1.1. The company is a major supplier of goods to Whole Foods, and now with Amazon.com in the picture, the outlook remains a bit uncertain, but this is a key reason why the stock has sold off and is partly what makes the shares a value at current levels.
Kelly Services Inc., the staffing company, is a small-cap name that carries a valuation well below that of the market. The stock boasts a P/E of 7.4 and a price-to-sales ratio of 0.2. The low price-to-sales is one of the reasons my Fisher-inspired investment model, which is based on the book Super Stocks by successful money manager Ken Fisher, scores the stock so highly.
Shares of DSW Inc. have been under pressure along with much of the retail industry over the past year. As a result of the stock's decline, the shares sport a P/E of 12 and a P/S of 0.5, helping the stock score highly through the lens of the Graham model, based on his writings in the Intelligent Investor, and the Fisher quant-based approach.
As with all my ideas, this list should act as a starting point, and you should only consider these stocks in the context of a diversified portfolio and after you've done your own research.