Stocks in 2001: Which Strategy Will Prevail?
A year of big gains for previously overlooked and trampled-under stocks has done nothing to convince “value” investors that there aren’t many more market lemons waiting to be turned into lemonade.
Value investing--which focuses on companies with low debt, high cash flow and/or low price-to-earnings multiples--had a huge rebound in 2000 after being trounced by “growth” investing for two straight years.
Value proponents note that the cycles of either growth or value dominating the market can be long in duration, and they contend that 2001 should be another winning year for their discipline.
Though the Federal Reserve Board’s surprise interest rate cut last week was cheered by growth investors as a tonic for their stocks, value managers argue that continued rate cuts will help certain value sectors shine even more brightly.
According to mutual fund tracker Lipper Inc., the average value fund gained 9.7% in 2000, while the average growth fund stumbled to an 11.7% loss.
That 21.4-percentage-point difference in performance was value’s biggest edge in at least 30 years.
Interestingly, growth’s biggest outperformance had come just a year earlier, when growth funds rode the tech-stock wave to a whopping 57.7% gain, compared with a modest 8.9% return for value.
With last Wednesday’s surge in many tech stocks after the Fed rate cut, some might suppose it’s back to the races for the growth sector. But value managers say many tech shares remain overpriced, and that their prospects aren’t likely to improve quickly in an economic slump.
A Fed rate cut “is a sign things are going down faster than we thought,” said David N. Dreman, the Red Bank, N.J.-based manager of the Kemper-Dreman High Return Equity Fund. The rate cut “doesn’t mean big new orders will be coming in tomorrow” for tech and other growth companies, he said.
Value managers use various measurements, including price-to-cash-flow, price-to-book-value and price-to-earnings, but their basic goal is to buy stocks at a discount to what they consider current fair value.
They tend to be less focused on long-term sales and earnings forecasts than growth managers, and they like to leave themselves a margin for error. The discipline generally leads to fewer costly portfolio mistakes, though it also means missing out on some big winners.
“Our approach will miss a Dell Computer” in its early years, acknowledged Glenn R. Carlson, managing partner at Brandes Investment Partners in San Diego.
A few Internet or biotechnology companies selling at stratospheric price-to-earnings multiples today eventually will, like Dell, justify their investors’ faith by delivering years of 30% earnings growth, Carlson acknowledged. But the vast majority will fall by the wayside, he said.
To David A. Katz, manager of its Matrix Advisors Value Fund in New York, a value stock is “any company at the right price.”
For example, “We like Motorola (ticker: MOT) at $20 but we won’t take any at $25,” he said.
Although he won’t pay “growth” prices, Katz looks for cheaper entry points to industries such as drugs, financials and technology that he can be confident will grow steadily for the next 10 to 15 years.
By contrast, with such cyclical industries as steel, autos and airlines, he said, “if you’re wrong on the timing, you miss out entirely.”
His caveat about timing aside, Katz noted that banks “tend to be wonderful investments during the first 75% of a Fed easing.” He likes Bank of America (BAC) because it has a “great footprint” in fast-growing U.S. markets, and it sells at a discount to other big banks.
Dreman is betting that already-depressed shares of retailers such as Gap (GPS), Best Buy (BBY) and Federated Department Stores (FD) will perform well even in an economic slowdown. In fact, all three have bounced up in recent weeks.
The incoming Bush administration should go easier on tobacco companies than Al Gore would have, and therefore Dreman thinks there is still “a lot more recovery” in store for Philip Morris (MO), despite the stock’s near doubling last year.
But Dreman would shy away from cyclical stocks if the economy is headed for a deeper slowdown.
Other value players, however, think that depressed cyclicals could shine if the Fed’s efforts succeed in heading off a recession.
Kevin Risen, co-manager of the Neuberger Berman Guardian Fund, said that paper and chemical companies, for example, have had such miserable returns for years that many of the firms have stopped investing in new plant capacity.
Finally, demand is outstripping supply for some of their products, he said, and the result should be higher returns. Many paper and chemical stocks have rallied in recent months.
Risen also has been buying some long-distance phone companies, including AT&T; (T), “which everyone on the planet hates.”
Last year’s tech blowup slashed the flow of capital to smaller new carriers, thus curtailing an expensive infrastructure-building arms race. With the easy-money spigot turned off, giants such as AT&T; can slow their spending to a more reasonable level and pass the savings on to shareholders, Risen said.
“I may hate these businesses,” he added, “but at some point, the stocks are stupid-cheap, and you don’t have to apply new valuation techniques to justify buying them.”
Pioneer Group’s Richard E. Dahlberg, manager of the Pioneer II fund, thinks the Nasdaq surge that climaxed in March was similar to the “Nifty Fifty” craze of the early 1970s, when the only market winners were a handful of anointed blue chips.
“Value came out of the Nifty Fifty era with a nice two- or three-year run,” Dahlberg said. The same thing started last spring when leadership shifted from big-cap tech stars to beaten-down energy, utility and tobacco stocks, he said.
If history repeats, the value cycle could easily last through 2001, Dahlberg said, noting that there remains “a tremendous valuation disparity” between the biggest blue chip stocks and the rest of the market.
Meanwhile, though some investors hate volatility, it can be friendly to value managers because it means opportunity, said Robert A. Olstein, manager of the Olstein Financial Alert Fund in Purchase, N.Y.
In the tech blood bath of 2000, for example, “they’ve taken some of the innocent along with the guilty.”
Among the tech stocks unjustly battered, in Olstein’s opinion, are American Power Conversion (APCC), whose devices protect computer systems from power interruptions; LSI Logic (LSI), in data storage, and computer-chip makers Cypress Semiconductor (CY) and International Rectifier (IRF). All four are selling at P/E multiples well below the S&P; 500 average.
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Thomas S. Mulligan can be reached at thomas.mulligan @latimes.com.
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Value Fund Favorites: A Sampling
Here are some blue-chip stocks favored by major mutual funds that follow a “value” investing strategy, how the stocks performed in 2000, and their performance in the first week of the new year. Profit-taking in many of the stocks last week further reduced their price-to-earnings ratios (P/E) based on estimated 2001 earnings per share--making them greater values, their fans argue.
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Ticker Fri. Gain in YTD 2001 Stock symbol close 2000 chng. P/E Washington Mutual WM $46.69 +105% --12% 11 Philip Morris MO 40.13 +91% --9% 10 Allstate ALL 38.06 +81% --13% 13 Wellpoint Health WLP 100.19 +75% --13% 17 Waste Management WMI 27.25 +61% --2% 19 Amer. Elec. Power AEP 40.81 +45% --12% 12 Fannie Mae FNM 78.94 +39% --9% 16 Bank One ONE 38.75 +15% +6% 14 Exxon Mobil XOM 83.25 +8% --4% 19 SBC Commun. SBC 50.00 --2% +5% 20 S&P; 500 index 1,298.35 --10% --2% 21
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Source: Times research; earnings estimates from Zacks Investment Research or IBES Intl. (BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Value Vs. Growth: The Long View
“Value” investing, which focuses on arguably cheap stocks, was a winning strategy in 2000 after two years of trailing behind “growth” investing, which tends to favor highfliers. But the two disciplines have traded the performance lead many times since 1985. Returns each year for the average growth stock mutual fund and the average value stock fund.
