Why I’m not giving up on value stocks

A little over a year ago, I wrote that value stocks are making a comeback. After lagging growth stocks for over a decade, value stocks beat growth in 2022 and have begun to dominate.

But I got ahead of myself. Over the past 12 months, the S&P 500 Value index did well, returning 15.3%, but the S&P 500 Growth index did much better, gaining 32.5%. The Russell 1000 Value index, which is calculated differently and includes midsize stocks, did even worse than the Russell 1000 Growth index, returning 13.1% compared with 33.5% for Growth. (Returns and other data are as of June 30; stocks I like appear in bold.)

I’m not giving up. Of course, timing the market is impossible, but value and growth move in cycles, and there’s a good reason that value’s turn has finally come.

Subscribe Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s free e-newsletters

Profit and prosper with the best expert advice on investing, taxes, retirement, personal finance and more – straight to your inbox.

Profit and prosper with the best expert advice – straight to your email.

Value stocks are stocks that are unpopular with investors, as evidenced by lower valuations. This usually means that earnings growth may be steady but far from spectacular. S&P uses three metrics to identify value: lower price-to-earnings (P/E), book-to-value (P/B), and sales-to-sales (P/S) ratios. Russell believes that value stocks have lower current P/B ratios, as well as slower growth in book-to-value, earnings, and sales over the past five years, and lagging sales forecasts for the next two years.

Value led growth in the 1980s, and growth dominated in the 1990s. When the tech bubble burst in 2000, value gained the upper hand for seven years before giving it back to growth. Over the past decade, the S&P Growth Index has outperformed Value by an average of more than five points per year. That’s a remarkable performance, especially considering 2022: the Growth Index is down 29.4%, while Value is down just 5.2%.

Everything revolves around technology stocks

Large-cap growth stocks have been doing well recently for two big reasons: first, the spectacular rally in technology stocks, which make up 63% of the S&P 500 Growth Index and just 13% of the Value Index; and second, low interest rates, which tend to favor fast-growing companies that take on debt to fund capital expenditures and research and development.

BofA Securities released a report in June that said, “After two decades of consistent underperformance, U.S. value could once again outperform growth.” The report referenced a seminar from 50 years ago called “The Renaissance of Value,” led by Benjamin Graham, the all-round investment guru who mentored Warren Buffett. It was time, the BofA analysts wrote, for another renaissance.

The impending resurgence in value, they wrote, makes sense both on the upside (as value stocks in long-neglected sectors catch up) and on the downside (as tech sector earnings suffer a “hard landing” from the current round of Fed rate hikes, and value stocks do relatively better than growth stocks falling from greater heights).

Finally, the analysts wrote, “the macro shift from a ‘2% world to a 5% world’ (a reference to market interest rates) supports value stocks.” At higher rates, value stocks should outperform the 5 percentage point increase per year, if history is a guide.

I find this reasoning compelling, and I have two other arguments for value. The first is the instinct that it’s time for a change. Growth has been king for almost two decades. That’s enough. Trees don’t grow to the moon. My second argument is much more compelling. The point is that value has easily outpaced growth over the long term, and there’s no reason why that trend won’t continue.

Growth is good. Opportunities are better.

Why does value beat growth? Because cheap beats expensive. Investors often shy away from value stocks because they get bored with consistent performance and need excitement. They want to jump on board something new and hot—not the old, tried and true.

Value stocks are therefore “mispriced” on the low side, just as growth stocks are priced above their true value. The proof is in history. Over the past century, value stocks have beaten growth stocks by more than four percentage points per year on average—a huge advantage in the investing world. What’s more, while investors typically earn higher returns for taking on more risk, value stocks actually have about 10% less risk, based on the standard deviation, a measure of volatility.

There’s currently a gulf between value and growth valuations. For example, S&P Dow Jones Indices reports that the average P/E ratio, based on analysts’ earnings forecasts, for the S&P 500 Value index is 16.3; for the growth index, it’s 27.5. The average P/B ratio for value is 2.7; for growth, it’s 9.6. The S&P 500 Value index has a dividend yield of 2.3%; for growth, it’s 0.7%. (Higher yields are an indicator of value.)

Since stocks often move between value and growth categories, the best way to invest in value is through an index-linked ETF. The best choice is iShares S&P Value ETF (LIFE(, 182) AND Vanguard S&P 500 Value (WOW$176)In the case of a portfolio consisting of smaller stocks and having an even lower share of technology stocks, it is important to consider iShares Russell 1000 Value (MDK(, 174) AND Vanguard Russell 1000 Value (WONV$77)All of these ETFs have an expense ratio of less than 0.2%.

In its latest deep dive into value, BofA recommended three sectors as particularly attractive: utilities, energy, and banks. I completely agree. Utilities and energy have risen in value, but they still have low valuations and are poised for revenue growth as demand for electricity increases (partly due to the need to power computational AI and electric vehicles) and there are obstacles—many of them political—to increasing supply.

Utility stocks can be purchased through ETFs such as: Select SPDR sector (XLU(68 dollars) AND Fidelity MSCI Utilities Index (FUTES(44 dollars); energy through Select Energy Sector SPDR (XLE$91) AND Van Eck Oil Services (OIH(316 dollars); and banks through Invesco KBW Bank (KBWB(54 dollars) AND SPDR S&P Bank (KBE(46 dollars).

You can also look for individual stocks that offer good value. There are few greater investing pleasures than successfully backing a company that “Mr. Market” ignores or outright hates. Here are a few candidates: ExxonMobil (XOM(115 dollars)with a P/E ratio of 12 and a dividend yield of 3.3%; JPMorgan Chase (JPM(202 dollars)with a P/E ratio of 13 and a profitability of 2.3%; Deer (DE($374)with a P/E ratio of 15 and a profitability of 1.6%; Johnson & Johnson (JNJ$146)with a P/E ratio of 14 and a yield of 3.4%. All four stocks are part of the S&P 500 Value Index.

Just remember, value investing requires conviction and a long-term horizon. In his remarks at a value renaissance seminar 50 years ago, Benjamin Graham said it best: “If you believe—as I have—that the value approach is inherently sound, workable, and profitable, then commit yourself to that principle. Stick to it, and don’t be fooled by Wall Street fads, its illusions, and its constant pursuit of the fast dollar.”

James K. Glassman is the president of Glassman Advisory, a public affairs consulting firm. He doesn’t write about his clients. His latest book is Safety net: a strategy for reducing investment risk in times of turbulence. He does not own any securities listed here. You can contact him at [email protected].

Note: This article first appeared in Kiplinger Personal Finance Magazine, a monthly, trusted source of advice and guidance. Subscribe to make more money, keep more of it Here.