During the great bull runs of the past two decades, finding value on Wall Street was child’s play. Novice investors struck gold day trading, and fund managers reaped huge returns at practically every turn.
But since the stock market’s 2008-09 meltdown, value investing has been no easy chore. Yet that hasn’t stopped the dedicated from scouring the world for the next big thing.
Value investors typically try to look beyond the markets’ daily ups and downs. Instead, they focus on fundamentals such as price-to-book and price-to-earnings ratios to ascribe value.
In most cases, value investors try to use their research to identify stocks whose book values exceed market valuations—essentially they’re looking for a good company whose stock is “on sale.” They often look for companies that investors have shunned despite strong fundamentals. At the same time, they avoid the hype that can drive sharp shifts in stock prices.
Other investors follow the more immediate trends and favor so-called growth stocks, those that are expected to outperform their industries in the near term. Growth stocks, despite their allure, might not pass a value investor’s muster if the fundamentals suggest their rallies are unsustainable.
Wally Weitz, founder of the Weitz Fund Group in Omaha, Neb., says finding cheap stocks with rosy futures requires both acumen and tenacity. And it demands a willingness to stick with an investment even as it is buffeted by a roiling market.
“You need a temperament not to panic when prices go down and the patience to wait for a price to rise,” Weitz said. “The ideal stock is attached to a company with a business that is fairly predictable, that generates more cash than it needs. It has good management and strong reinvestment opportunities.”
Weitz, whom some have dubbed “the other Oracle of Omaha” (after investing legend Warren Buffett), said value investors need “a long runway.” Even a well-vetted investment might not pay off in the near term.
Texas Instruments is one of Weitz’s recent favorites. The company, which became a household name selling pocket-sized calculators in the 1970s, fell from favor. But Weitz said the company has undergone a turnaround in recent years that was widely overlooked.
“We went through their financials, and we started buying,” Weitz said. He said the company, also known for its cell-phone chips, scored a coup during the market meltdown, cornering $1 billion worth of chipmaking equipment for $150 million. He said it is turning that investment into solid growth.
“We think the company’s earnings could go from $2.40 [a share] to $5, $6 or $7 over the next few years.” Weitz said.
Undervalued Stocks Are Still Plentiful
Value-investment specialists say cheap stocks remain plentiful. Some are attached to little-known companies bringing new products to market. But others, like Walmart Stores, are consumer favorites that are well-poised to prosper during an austere period.
“People stopped liking stocks in 2008, and they still don’t,” said David Winters, CEO of the Wintergreen Fund (Nasdaq: WGRNX). “The financial crisis chased people out of stock funds and into cash and bonds. The situation created values as a result of the lack of interest.”
Winters favors international companies, especially those that are well positioned to take advantage of growth in Asia, South America and Africa. “Our perspective is that the high debt levels in the United States and Western Europe will make it hard for companies operating there to capitalize on opportunity,” he said.
But companies based in the West with customers in growth markets are in good positions to expand, he said. One of his favorites is Nestlé S.A., the Swiss food-products and confectionery maker.
“The bulk of Nestlé’s business is international, and the company has an [annual] organic growth rate of about 6 percent,” Winters said. “We like the underlying products—instant coffee, milk formulas and chocolate brands. It’s a First World company that gives you exposure to the growth occurring in the growing parts of the world.”
Winters also likes energy companies, including Canadian Natural Resources, an oil-exploration company. He favors diversified businesses in growth markets, mentioning Jardine Matheson Holdings Ltd., a Singapore-based company with holdings in food retailing, insurance, motor vehicles, land and hotels.
But he is leery of the health-care and pharmaceutical sectors. “We’re staying away from health care,” Winters said. “Many of [those paying the bills] in the health-care sector are governments, and they determine future prices.”
Lewis J. Altfest, president of Altfest Personal Wealth Management in New York, disagrees on that point. He said a number of drug companies are strong value plays.
“Some of these companies haven’t been performing too well because of government interference and the fact that they haven’t been releasing a lot of new drugs,” Altfest said. But many are worth more than they are trading for today.”
Altfest said Pfizer deserves consideration. He also likes low-profile companies with solid financials and international exposure. “There are quite a few plain-vanilla companies out there worth more than they are selling for,” he said. “The market often overlooks that some of these have 40 percent of their earnings coming from overseas.”
And Altfest favors U.S. companies whose stock prices have dropped in the past several years over Asian companies that rallied during the Wall Street downturn.
“China and India are growing nicely, but they don’t represent real value,” Altfest said. He said value investing often requires a contrarian attitude and a sharp focus on profit-to-earnings ratios that signal stocks trading at bargain prices.
“The mindset for value investing is to imagine yourself going to a cocktail party and having everyone sticking their tongues out when they hear what you’re doing,” Altfest said. “You have to be looking three years ahead of what other people are focused on.”
That’s a theme that resonates with Connor Browne, portfolio manager of the Thornburg Value Fund (Nasdaq: TVAFX).
3 Categories of Value Stocks
“We have always believed the best values are found in out-of-favor companies,” Browne said. He divides value-investing targets into three categories: basic value companies, consistent earners and emerging franchises.
Basic value companies are strong producers trading at a discount. He offered financial giant JPMorgan Chase as an example. He said the company’s acquisition of Bear Stearns and Washington Mutual during the financial meltdown will position it for strong growth as the financial markets recover; he said it remains undervalued.
Consistent earners are businesses in markets that are likely to remain strong into the foreseeable future. Gilead Sciences, a drug maker that specializes in HIV medications, is one such company.
“Gilead is at the forefront of its field, but investors are pessimistic because of health-care reform in the U.S. and Europe,” Browne said. But he said 80 percent of HIV patients take the company’s drugs now, and lengthening survival rates are adding to demand for its treatments.
Finally, emerging-franchise companies are those growing faster than the overall economy. Browne said investors would be wise to pounce on these companies before mainstream Wall Street does. One such company, Varian Medical Systems, develops and sells radiation equipment for cancer treatment.
“They are innovating and have exciting products,” Browne said. “U.S. orders are up 20 percent.”
He said there are 128 oncology machines in the United States for every 1 million people over age 65. In China, he said, there are 11. “The potential upside is very large,” he said.
Browne said a recovering stock market is usually good for value investments.
“Value investing is always a good long-term strategy, but there are times when it works well and times when it doesn’t,” he said. “The worst thing a value investor can do is buy when things are going well and sell when they aren’t. Value investing is for contrarians.”
Christopher Boyd, a former business reporter for the Miami Herald and Orlando Sentinel, is a freelance writer based in Orlando, Fla. He also was a page-one columnist for the Miami Daily Business Review and Southeast correspondent for the Boston Globe. Boyd also has written for The New York Times, Newsday, the Chicago Tribune, The Dallas Morning News and other publications. He is a frequent contributor to WEALTH.
What is Value Investing?
“Value investing” refers to a philosophy that drives the way an investor approaches selecting stocks. It is about finding stocks that the market has not correctly priced—those that are worth more than is reflected in the current price. The value investor is more concerned with the business and its fundamentals than other influences on the stock’s price, such as daily news headlines or market movements as a whole. Fundamentals such as earnings growth, dividends, cash flow and book value are more important than market factors on the stock’s price. Value investors typically are “buy-and-hold” investors who stay with a company for the long term.
Examples of Value Stocks
Varian Medical Systems Inc. VAR
Wal-Mart Stores Inc. WMT
JP Morgan Chase & Co. JPM
Texas Instruments Inc. TXN
Gilead Sciences Inc. GIlD
Pfizer Inc. PFE
Nestlé SA NSRGF
7 Characteristics of a Value Investor
- Conducts thorough research to find undervalued stocks
- Is prepared to weather storms of market volatility
- Spots companies whose earnings exceed the pace of economic growth
- Looks for bargains in a recovering market
- Finds companies positioned to do well in high-growth markets
- Will often take a contrarian approach to that of other investors
- Is prepared to hold stocks for the long term