John E. Maloney, chairman and CEO of M&R Capital Management
Value investing has been at a low ebb for nine years now. While a near-term rebound is doubtful, one surely is coming: Investing cycles turn, eventually. The key is to be ready for when the ground shifts.
A value investor searches out quality stocks the market has overlooked, buying the undervalued shares on the cheap and then profiting when the world wakes up to their true worth. Two celebrated academics, Kenneth French and Nobel laureate Eugene Fama, showed in their research that a value strategy delivers the best returns over time.
Since the early days of the housing crisis, the glamour of value's opposite — growth investing — has reigned. The growth approach focuses on stocks with rapid price appreciation, often but not always accompanied by surging earnings and epitomized by tech firms. The so-called FANG stocks (Facebook (FB), Amazon (AMZN), Netflix (NFLX) and Google, which is now called Alphabet (GOOGL)) are growth's leading lights.
At least for the moment, the performance difference between value and growth has flipped. Thus far this year, the Russell 1000 Growth Index is up 2.3 percent, and the Russell 1000 Value Index leads with 4.4 percent. And the FANG stocks, which romped in 2015, have underwhelmed lately: Three of them are down in 2016, with only Facebook ahead.
Value's last heyday was from 2000 through 2006, in the wake of the tech bubble. The best time for value is when there's decent economic activity. With gross domestic product rising nowadays at a meager 2 percent yearly, the fuel to ignite a new era of value investing is not present. Corporate revenue expansion is slowing, so companies turn to cost-cutting, stock buybacks and financial engineering.
Finance stocks make up a large portion of the value universe. These shares, particularly those of banks, need higher interest rates, which of course are a by-product of a better economic tempo.
Higher rates would mean improved net interest margins — the difference between what lenders pay for deposits and what they charge for loans, which is higher. At last count, according to the St. Louis Federal Reserve Bank, the difference was 3 percentage points, below even the level during the Great Recession, when it was 3.2.
Banks are so cheap that it's hard not to want to own them. Many are trading below book value, representing what a company would fetch if it were liquidated, calculated by subtracting liabilities from assets.
In fact, many of these stocks change hands for less than another measure — tangible book value — which leaves out goodwill, an accounting yardstick for non-physical items such as a company's brand name and customer base.
At the same time, investors are pulling their money out of actively managed mutual funds, preferring index funds, which have low costs and mirror the overall market.
This exodus hurts both value and growth stocks, but with value now out of fashion, it suffers more. Value-oriented fund shop Royce Associates, for instance, has seen half its assets flee over the past two years.
But any good value investor knows that times like these spell one thing: a buying opportunity. Good stocks are on sale. Here is a look at some of the most compelling value plays today.
Media. While this is a very diverse sector, those that provide content on the TV screen and, to a lesser extent the silver screen, have seen their stocks unjustifiably pummeled. Streaming video, underscored by Netflix's climb to prominence, cast a shadow over this group. But anticipating its decline is premature.
Consider Time Warner (TWX), which, having shed its magazine properties and cable network, is a pure-play entertainment company. It trades at 12 times forward earnings, below the Standard & Poor's 500 index (^GSPC) average of around 17. Cable channel HBO is an enormously successful platform for original programming, and now it is available online at cut-rate prices, expanding its reach. CNN, the news operation, is doing well, thanks to the rollicking U.S. presidential race.
Meanwhile, Twenty-First Century Fox (FOXA) is in a similar situation, with a forward P/E of 14.4 and a lagging film division. But the movie segment has a robust batch of summer offerings, such as sequels to "X-Men" and "Independence Day."
Fox News is the leader among TV news outlets. And Fox has a killer sports franchise, with the rights to the National Football League, Major League Baseball and college football. Televised sports have an advantage over other programming, which viewers record so they can skip over the commercials: People want to see games in real time.
Finance. Citizens Financial Group (CFG), whose projected P/E sits just below 11.1, is one of the nation's leading regional bank companies, with 1,200 branches spread over the Northeast and the Midwest. Spun off by Britain's Royal Bank of Scotland two years ago, Citizens has beefed up its mortgage lending to take advantage of the housing recovery.
Insurer American International Group (AIG) was at the epicenter of the financial crisis and survived only due to a huge government bailout. At a forward P/E of 9, AIG still is struggling to shed the last of the old problems but appears poised to regain its footing. It has a reach that makes it a force around the world and a sizable property-casualty business. Higher interest rates, when they come, will buoy its life insurance lines.
Energy. This is the most beaten-down industry going, given the epic slide in oil prices. Net income has tumbled, and many of the smaller energy companies have gone bust.
But the large integrated oil majors are a different story. They are, for instance, still paying nice dividends. The reason is that, despite the plunge in their stocks, the majors have the resources to weather this storm. And they have done that before, as in the 1980s, when petroleum prices cratered.
ExxonMobil (XOM) and BP (London Stock Exchange: BP.-GB) are two cases in point. Both have strong balance sheets. Exxon, which not too long ago was the most valuable company in stock valuation terms, has a formidable refinery arm, allowing it to make money even on bargain oil.
BP has struck a deal to put the biggest liabilities from its Gulf of Mexico oil spill behind it. The company has embarked on a cost-cutting campaign that should help it going forward. And it has reduced its large exposure to Russian oil ventures, which many viewed as too risky.
Value investing is not for the faint of heart. But as professors Fama and French know, it pays off in the end.
— By John E. Maloney, chairman and CEO of M&R Capital Management
