There's a place for stocks trading at low valuations (generally referred to as value stocks) in a well-rounded investment strategy. History shows that the relative performance between value and growth stocks can sometimes move back and forth like a game of tug of war.
But the underperformance of either group has never been this lopsided. Research from Patient Capital Management found that, between 2007 and 2020, value stocks underperformed growth stocks by 150% -- the worst performance by either group in the last 50 years.
While growth stocks generally are the best way to grow your savings over the long term, identifying stocks trading at low valuations or price-to-earnings (P/E) ratios can be beneficial when the markets turn volatile.
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For example, through the market correction in 2022, the Vanguard Value ETF significantly outperformed the Vanguard Growth ETF, which shows how well-chosen value stocks can offset the declines in your growth stocks when the markets slide. The key is to be selective and focus on quality companies that lead their respective markets.
Here's why Chinese e-commerce leader Alibaba(NYSE: BABA) and jeweler Signet Jewelers(NYSE: SIG) are two great value stocks to buy right now.
1. Alibaba
The largest e-commerce and cloud services provider in China, a company that generates $130 billion in annual revenue, is trading at a fire-sale valuation of just 6.3 times trailing-12-month free cash flow. The stock has fallen over the last few years due to a weak economy, concern about U.S.-China relations, and increasing competition in e-commerce in China. Its price is getting too cheap to ignore.
Despite the obstacles, the stock's reduced valuation doesn't seem justified. Alibaba has enormous cash resources to reinvest in the business and weather the economic turbulence. It also is facing a massive opportunity in the growing adoption of artificial intelligence services in China.
McKinsey & Co. estimates AI could add $600 billion in economic value to China in the years to come. That is almost as much as the entire gross domestic product of Shanghai, one of China's largest cities.
Alibaba has the customer reach and technology to be a leader in China's booming AI economy. The company's Taobao marketplace had 895 million monthly active users through September 2023. Management credited the growth in its core marketplace business in the September-ending quarter to its wide offering of brands and merchants, in addition to AI-driven technology, such as virtual try-on features in the app.
Despite these advantages, revenue growth from Taobao and Tmall still decelerated last quarter to just 4% year over year. The competition from other marketplaces and macroeconomic challenges are taking their toll, but Alibaba has tools to fight back. The company has yet to fully flex its financial strength to more aggressively lower prices, which could put more pressure on smaller competitors.
All told, Alibaba's technology, wide customer reach, and profitability, where it generates $30 billion in trailing free cash flow, are worth betting on at these bargain-basement share prices. The stock could be a grand slam for investors if the stock eventually returns to the same price-to-earnings valuation as before the pandemic.
2. Signet Jewelers
Investing in top jewelry brands can be a rewarding investment at the right price. Signet Jewelers operates the largest collection of store brands, including Zales, Jared, Kay Jewelers, and online leader Blue Nile, among others. It's not a fast grower, but management has implemented a successful acquisition strategy to assemble this leading collection of brands, and the stock is cheap enough to deliver spectacular returns over the next five years.
After a slump in sales over the last few years, the company saw demand for engagement rings rise toward the end of 2023. Improving sales in bridal, which generates half the company's merchandise sales, is a catalyst for growth.
Signet's sales were down 12% year over year last quarter, as the company's bridal business is expected to remain soft in the near term. But sales of engagement rings build long-term relationships with customers, and this fuels growth in services, which could be a source of expanding margins down the road.
Signet management projects annual adjusted earnings will reach at least $14 per share over the long term as bridal demand returns. That puts the stock's forward price-to-earnings ratio at just 7 -- a bargain, considering the company's record of profitable growth.
The stock rallied at the end of last year following healthy Black Friday sales in the holiday quarter. Moreover, Signet pays a small dividend yield of 0.93% to shareholders, reflecting management's confidence in the future.
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John Ballard has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard Index Funds - Vanguard Growth ETF and Vanguard Index Funds - Vanguard Value ETF. The Motley Fool recommends Alibaba Group. The Motley Fool has a disclosure policy.
