Getty Images
It’s been a tough time to be a traditional value investor — those who pore through companies’ financial statements looking for buried treasure and whose well-worn copies of Graham and Dodd sit next to the Bible on their bookshelves.
Some who’ve stuck to their guns, like famed hedge-fund manager David Einhorn, have been pummeled. His Greenlight Capital reported an 18% loss so far in 2018 and he wrote investors: “Right now the market is telling us we are wrong, wrong, wrong about nearly everything.”
Others have simply capitulated to the market power of the FAANGs (Facebook FB, +4.45% Amazon AMZN, +1.34% Apple AAPL, +0.52% Netflix NFLX, +2.28% and Google parent Alphabet GOOG, +0.09% GOOGL, -0.04% ) and, like Bill Nygren or Chris Davis, declared one or more of these highfliers to be value stocks at heart.
Actually, value stocks—shares of companies which fund managers think are trading at discounts to their earnings growth or asset value—have done very well in the current bull market: Since the March 2009 lows, the iShares Russell 1000 Value ETF IWD, +0.26% racked up a 357.7% gain through last Friday. That topped the S&P 500’s SPX, +0.35% 319.8% advance and the Dow Jones Industrial Average’s DJIA, +0.16% 288.9% increase during that time.
But it trails the iShares Russell 1000 Growth ETF’s IWF, +0.52% gobsmacking 463.3% gain by more than 100 percentage points.
Thank the FAANGs and other super-momentum plays for that. Value and growth stocks’ gains were close in the early years of the bull market, but as Alec Lucas, senior analyst at Morningstar Research Services LLC, told me: “Generally speaking, in the post-financial crisis era, growth has been the place to be. That’s been especially pronounced since, essentially, year-end 2016.”
And yet, he points out, academic research (going back to Nobel Prize winner Eugene Fama and Kenneth French’s seminal 1992 paper) has demonstrated value outperforms growth over the long run.
From June 30, 1927 through December 31, 2016, value stocks’ annualized return was 13.5%, outpacing growth stocks’ 9.2% return by a wide margin, according to AFAM Capital.
Of course growth can outperform for long periods; we’ve been living through one for almost a decade. But in stock investing, price and fundamentals eventually win.
Many pundits have heralded the rotation to value for quite a while, though it hasn’t materialized. But there are good reasons it’s time to shift at least some money to the value camp.
There’s only one way to describe that move—off the charts, though we don’t yet know if it represents the Big Shift to value.
Second, Lucas points out that investors have seen this movie before.
“That kind of pronounced underperformance since year-end 2016 through June 2018, you saw....prior to the dot-com era,” he told me. “Up to year-end ’97 you see a nip and tuck between value and growth, but with value a little bit ahead.
“Starting in ’98, value underperformed pretty dramatically until February 2000—the early 2000s bear market starts in March 2000—then you see massive, sustained outperformance of value stocks…all the way through July 2006.”
“If you believe in the long-term value premium, you can make a case this is actually the time to be increasing value exposure. You can see extended underperformance for another two years, but [you’ll] have a good chance of doing well over the next five to seven years.”
That’s why I’d take some profits on highflying FAANG stocks (or even a technology fund or ETF) and put no more than 5%-10% of your investible money into value stocks.
The iShares Russell 1000 Value ETF I mentioned before is a good choice, as is the Vanguard Value ETF VTV, +0.28% which has had better five-year performance and an unbeatable 0.05% expense ratio. (Yes, you read that correctly.)
This may be one area where active managers can add, well, value, and Lucas recommends three funds from Milwaukee-based FMI—FMI Large Cap FMIHX, +0.36% FMI Common Stock FMIMX, +0.62% and FMI International FMIJX, +0.24% He likes managers Patrick J. English and Jonathan Bloom’s “value disciplined” approach, and their expense ratios are 1% or below. Morningstar rates all of them silver or gold—or four or five stars, if you prefer celestial bodies to precious metals.
Howard R. Gold is a MarketWatch columnist and founder and editor of GoldenEgg Investing, which offers exclusive market commentary and simple, low-cost, low-risk retirement investing plans. Follow him on Twitter @howardrgold.