Value Hunt Getting Tougher on Wall St.
In the stock market, “value” investors tend to identify with that old Groucho Marx line: “I don’t care to belong to any club that will have me as a member.”
To put it another way, the search for real value in the market is supposed to take you away from the crowd, away from whatever is widely accepted to be a smart investment at the moment. But what if the masses believe that traditional value stocks are the best place to be?
In fact, that has been the judgment of the crowd for the last few years. And it’s making life increasingly difficult for veteran value-hunters like John Spears, who helps manage the Tweedy Browne American Value mutual fund in New York.
Asked if he can find cheap stocks in this market, Spears doesn’t hesitate.
“No. None,” he says.
Of course, value -- on Wall Street or anywhere else -- is in the eye of the beholder. A stock may be judged to be a value when it sells for a relatively low price compared with underlying earnings per share, or compared with some measure of the intrinsic worth of the company’s assets. But there’s always a lot of room for disagreement about how cheap is truly cheap.
However they measure it, many value hunters say they can’t find what they’re supposed to be looking for.
For some, the problem has become much more acute over the last year, as nearly every stock market sector has zoomed.
For the man considered to be the modern-day godfather of value investing, Berkshire Hathaway Inc. Chairman Warren Buffett, the perceived shortage of attractive stocks has been a barrier to putting cash into the market for much longer than the last 12 months.
“In recent years, we’ve found it hard to find significantly undervalued stocks,” Buffett lamented in his 2004 letter to shareholders issued March 6, in a now-familiar refrain.
To which Berkshire shareholders, and others who own value-focused funds, might reply: “Whatever it is you’re doing, just keep doing it.”
This year, the average mutual fund that owns large-capitalization value stocks is up about 0.4%, according to fund tracker Lipper Inc. in Denver. The average large-cap “growth” fund, by contrast, is down 0.5%.
Large-cap value funds also top large-cap growth funds over the last one year, three years, five years and 10 years, Lipper data show. (Morningstar Inc., which also tracks fund performance, comes up with similar numbers.)
As for Berkshire Hathaway, its class A shares are up 8.8% this year to $91,700 as of Friday.
The supremacy of value over growth -- the latter an investing style that usually centers on buying shares of the fastest-growing companies -- extends beyond the big-stock universe. Value also has been the better sector, by far, among small-cap and mid-cap stock funds.
Over the last five years, for example, the average small-cap value fund has gained an annualized 15.9%, compared with 5.8% for the average small-cap growth fund, Lipper data show.
No wonder the investing public is piling into value-oriented mutual funds. Those portfolios and other more conservative funds (such as stock-and-bond-mix funds, and funds that blend value and growth stocks) took in the lion’s share of net new cash from investors in 2003, according to data from Financial Research Corp. of Boston.
Pure large-cap growth funds didn’t rank even among the top-20 fund categories for net inflows.
Heavy cash inflows to any market sector can make strong performance a self-fulfilling prophecy, at least for a while. That may be helping to keep value stocks flying: As value-fund managers take in more cash, many tend to buy more of what they already own in classic value sectors such as banking, energy and heavy industry.
But company, in this case, is misery for many value-stock managers. Their style often is described as hunting for issues that either are under a rock or under a cloud -- undiscovered or underappreciated, or both. The idea is that, once the rest of the market comes to know what the value manager knows about a firm, the stock will be worth a lot more.
If what they own already is popular or well appreciated, the chance of market-beating long-term performance is lessened substantially, managers like Tweedy Browne’s Spears say.
His value discipline centers on searching for companies whose stocks are priced well below the net “enterprise value” of the business. Spears defines enterprise value as what a savvy investor would be willing to pay for the entire firm, knowing that the price would have to be reasonable enough to make sure the investment would pay off in the long run.
That focus necessitates “looking at stocks as something more than gambling chips,” Spears said.
As the market overall, and value stocks in particular, have rocketed since last March, the search has become futile, he said: “I don’t think we’ve had a new idea in a year.” Even so, his fund is up 1.1% this year, while the Standard & Poor’s 500 index is down slightly.
Historically, value and growth have traded leadership on Wall Street. Growth ruled in the late 1990s amid the technology-stock mania. This decade has belonged to value.
But for how much longer?
Investors’ post-bear-market fear factor would seem to continue to favor value, some pros say. Many people learned the hard way how dangerous it could be to overpay for growth stocks. That makes it easier to stick with value stocks, even if they aren’t the values they used to be. (It also makes it easier for brokers and other financial advisors to sell value stocks to clients.)
Ever-present in the back of the minds of value veterans, however, is that the crowd is often wrong.
In late 1999 and early 2000, the crowd wanted Amazon.com Inc., one of the symbols of the Internet craze. The company had no earnings at the time, but the bet was on long-term growth -- very long-term.
Plenty of non-tech stocks were ignored in that era, including cosmetics giant Avon Products Inc. At its low of about $25 a share in 2000, Avon was priced at about 13 times what it would earn per share that year.
As Amazon.com and other tech stocks crashed during the latter half of 2000 and in 2001, investors rediscovered the appeal of old-line value stocks like Avon. That has continued for the last three years. Last week Avon hit a record high, closing at $74.74 a share Friday. It’s up nearly 11% this year.
Amazon.com, while up sharply from its bear-market lows, is slumping again. At $41.70 on Friday, it’s down 21% since Jan. 1.
Measured solely by price-to-earnings ratios, Avon still looks like a value relative to Amazon.com: The latter sells for 43 times the 96 cents a share that analysts, on average, figure it will earn this year. Avon, by contrast, is priced at 23 times what analysts expect it to earn this year.
But Avon’s P/E ratio now is above that of the average blue-chip stock. It would be hard to argue that Avon is the value that it was in 2000.
Still, many value-fund managers say they continue to find opportunities in this market. That is, after all, what they’re paid to do.
Bob Corman, co-manager of the Neuberger Berman Focus fund in New York, cites El Segundo-based International Rectifier Corp., whose microchips manage power needs in cars, appliances and other machines.
The stock, at $45.32 on Friday, is priced at about 15 times what Corman thinks the company can earn, per share, in 2005. The market, Corman said, still appears to view International Rectifier as a commodity kind of business. He thinks the market is wrong, and that the company has huge growth opportunities ahead of it.
That’s one definition of value, Corman said: growth prospects that are largely unrecognized.
Tweedy Browne’s Spears, while disappointed with what he sees in the market overall, says he’s content to hold on to the value stocks in his portfolio, including names like American Express Co. and bond insurance firm MBIA Inc.
Some investment pros say it would be silly for value investors to simply throw in the towel on the sector. Paul Merriman, a Seattle-based money manager, said he still believed that “over the long run, value is the most consistent part” of the market in terms of performance.
But he also warns that the strong gains of value stocks in recent years mean the sector probably won’t offer great protection if the market as a whole slumps again soon.
Investors who are terribly afraid of losing money, he said, should be keeping a big chunk of their assets in short-term bonds or in cash accounts, rather than holding it all in value stocks just because those shares have held up well in this decade.
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Tom Petruno can be reached at tom.petruno@latimes.com. For recent columns on the Web, go to: latimes.com/petruno.
