- Value investing has made a comeback amid a strong economy, a hawkish Fed, and rising bond yields.
- Three value investors told us why the bargain-hunting strategy is poised to outperform this year.
- They also share 10 cheap value stocks in their portfolios worth scooping up in this downturn.
Value investing, the act of buying stocks trading well below their intrinsic value based on measures such as earnings and price-to-book, is back in vogue after years of underperformance.
The combination of a hawkish Fed, rising bond yields, and persistently higher inflation has weighed on expensive high-growth stocks, which derive their lofty valuations from cashflows that are further out in the future. Cheap value stocks, on the other hand, have proven to be a much better bet so far as Wall Street strategists forecast as many as seven Fed rate hikes in the year ahead.
Amid the market’s gut-wrenching swings in January, value stocks, bolstered by the energy sector’s 19% gain, had their best performance since the peak of the dot-com bubble.
From the end of November through the end of January, the S&P 500 Value Index rose 5.3% while the S&P 500 Growth Index fell 6.1%. The same reversal of fortune is playing out in fund flows. Since the start of the year, S&P 500 Value Index-based ETFs have gathered $2 billion as investors pulled a similar amount from S&P 500 Growth funds, Todd Rosenbluth, head of mutual fund and ETF research at CFRA, wrote in a Tuesday research note.
The early signs of outperformance and a changing macro-environment have given some long-standing value investors reasons for optimism. But the question remains whether the traditional bargain-hunting investing strategy is revived or short-lived as were those previous rotations into value stocks.
Insider spoke with three veteran value investors for their thoughts on the road ahead and the high-conviction stocks in their portfolios.
Colin McWey, vice president and portfolio manager at Heartland Advisors
McWey manages the $296 million Heartland Mid-Cap Value Fund, which returned 28.21% last year, according to Morningstar data.
McWey does not profess to be a market strategist, but he views the combination of inflation anxiety, Fed tightening, and higher interest rates as conducive to value stocks. A staunch adherent of Heartland’s 10 principles of value investing, he takes a bottom-up approach to conduct fundamental analyses of businesses across different sectors.
While value’s revival has had “a couple of head fakes” over the past few years, McWey is confident that value investing wins out in the long haul.
“Different types of styles and factors can have leadership for a long time, and that can lead people to have short memories,” he said in an interview. “If we’ve been in a growth-led market for as long as we have until recently, maybe people’s memories got a little bit short. Maybe it does reinforce the idea that the price that you pay, the valuations that you enter into investments with, is still really important.”
McWey’s top picks include First Interstate BancSystem (FIBK), Encompass Health (EHC), Spectrum Brands (SPB), and Skyworks Solutions (SWKS).
Jack Murphy, portfolio manager and Co-CIO at Easterly Investment Partners
Murphy manages the $39 million Easterly US Value Equity Fund, which was up about 23% in 2021, according to the firm’s performance statistics.
Murphy, who identifies as a contrarian value investor, said he does not just focus on the traditional value metrics such as price-to-earnings, price-to-book, and free cash flow, but also homes in on catalysts that could vastly improve the valuations of businesses in the next few years.
Although value stocks have been leading growth stocks for a few months, the dynamics will have to play out for a long time before the valuations of companies adjust to normal levels, in his view.
"If growth stocks fell 30% and value stocks rose 30%, that might get us back to parity," he said in an interview. "This would have to go on for a long time before we feel vindicated."
Murphy's high-conviction stock picks are Unilever (UL) and Steelcase (SCS), which he thinks have 25% and 50% upside, respectively. He also likes Bio-Rad Laboratories (BIO).
Chad B. Hoes, chief investment officer at Parkway Advisors
Hoes manages the $16 million Monteagle Select Value Fund, which beat 95% of its category peers to return 40% last year, according to Morningstar data.
Beyond identifying cheap stocks based on traditional valuation metrics such as low price-to-earnings, low price-to-book, and good cash flows, Hoes' fund uses a software tool to filter out companies that do not adhere to Christian principles.
The macro-environment and rotation into value from growth turbocharged the fund's outperformance last year, and Hoes expects value stocks to continue outperforming in a rising rate environment.
"We are expecting three or four rate increases this year in 2022," he said in an interview. "As rate hikes are happening and as the Fed continues their tapering, we do think that will return favor to value stocks over growth stocks."
Hoes said he sold out of top performers including Pioneer Natural Resources (PXD), Regency Centers (REG), and State Street (STT) at the end of last year in order to capture the gains on those stocks after they reached their target prices.