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Growth stocks have outperformed value stocks since 2005 and seem to be on an endless winning streak. But investors forget that growth stocks weren’t always the most favored equities, and value investing seems overdue for a return to leadership especially if the market turns bearish, according to Barron’s. Among the value plays highlighted by Barron’s are automaker General Motors Co. (GM General Motors Co.), department store chain Kohl’s Corp. (KSS Kohl’s Corp.) and agricultural fertilizer supplier The Mosaic Co. (MOS).
Value Tops Growth
Value stocks have outperformed growth stocks by an average of 4.8% per year in the eight decades between 1926 and 2005, based on research by professors Eugene Fama of the University of Chicago and Kenneth French of Dartmouth College, Barron’s says. Moreover, while growth has delivered better returns over the 12 years through April 2017, its average annual advantage over value has been just 0.7%, Barron’s adds. Nonetheless, poor performance by value stocks so far in 2017 has led many to forecast its demise as a viable investing strategy, a prediction that Barron’s finds premature. (For more, see also: Why Buffett-Style Value Investing Is Failing.)
In addition to looking for stocks with low price-earnings (P/E) ratios, another traditional screening methodology employed by value investors is to seek out stocks with low price-to-book value ratios. Barron’s used the latter methodology, finding five members of the S&P 500 Index (SPX) that are among the lowest in terms of price-to-book, as well as recommended by at least one top-performing investment newsletter. In addition to General Motors, Kohl’s and Mosaic, Barron’s also names agricultural commodities giant Archer Daniels Midland Co. (ADM Archer Daniels Midland CompanyADM), plus oil and gas drilling equipment supplier National Oilwell Varco Inc. (NOVNational Oilwell Varco Inc. NOV).
Reason to Favor Value
Relative to growth stocks, the average price-to-book ratio on value stocks has not risen over the past decade, according to Kent Daniel, a professor of finance at Columbia University cited by Barron’s. In fact, Professor Daniel tells Barron’s in its June 28 feature story that value stocks are cheaper than growth stocks by the widest margin over the past six decades, with the exception of the peak of the Dotcom Bubble. Indeed, between the bull market top during those bubble years and the ensuing bear market bottom in October 2002, value stocks beat growth stocks by a staggering 32% annualized rate, based on an analysis by professors Fama and French cited by Barron’s.That’s worth considering today, against a background of high valuations and fears of an impending market crash.
The Value Trap
“Some value stocks are cheap for good reasons,” Barron’s points out, warning that blindly using a screen such as price-to-book ratios without further investigation into companies’ specifics might lead investors to pick stocks that continue to get cheaper, rather than rise in price. As Barron’s notes, data on the relative performance of growth and value stocks represents averages of hundreds of stocks over time. Furthermore, the usefulness of book value as a valuation metric has been debated for decades, since it is based on accounting conventions tied to historical cost, and thus does not necessarily reflect the true intrinsic current value of a business.
While value stocks may outperform growth in a bear market or recession, this does not ensure they will post major gains as these companies confront industry headwinds. For example, the outlook for National Oilwell Varco is clouded by oil oversupply and falling prices, Kohl’s is in an retailing industry facing long-term troubles, and GM’s vehicle sales may have peaked with the rest of the industry. (For more, see also: Why Oil May Plunge to $30 a Barrel and Why Investors in Retailers May Bleed Even More.)