“Prices fluctuate more than values — so therein lies opportunity.”
If that quote from Wall Street legend Joel Greenblatt has it right, opportunities abound in the current market climate. You just need to know where to look.
That’s where a recent note from Alliance Bernstein’s James MacGregor, co-written by Cem Inal and Shri Singhvi, comes in.
“Value investing has always been about challenging the consensus — but never more so than today,” MacGregor wrote. “After several tough years, we’re seeing signs of a value recovery brewing. Yet fresh approaches are needed to capture the potential in today’s complex markets.”
The concept, of course, seems as sensible as ever: Sniff out the stocks that are undervalued and misunderstood, wait until their value is realized, and, voila, profit. Sounds easy, but if the last decade is any indication, it most definitely isn’t.
The underperformance of value stocks since the financial crisis has understandably caused skittish investors to lose faith in the time-tested approach, which counts such heavyweights as Warren Buffett BRK.A, -0.48% , Benjamin Graham and Seth Klarman as loyal adherents.
MacGregor points out that the numbers are, indeed, daunting. The Russell 1000 Value Index RLV, -0.23% has trailed the Russell 1000 Growth Index RLG, -0.14% by 3.5% annualized over the past 10 years.
“Value stocks are generally perceived as riskier and have suffered from a growing anxiety about trade frictions, interest-rate uncertainty, volatile oil prices and threats to economic growth,” MacGregor explained in the note. “Beneath the surface, however, we see promising signals.”
He used this chart to illustrate just how deeply discounted value stocks are to growth. As you can see, the current level isn’t something we see very often.
“Skeptics might argue that the discount is justified,” MacGregor wrote. “Perhaps value stocks are so much cheaper than growth stocks today because in a tougher macroeconomic environment, investors believe that growth stocks offer some immunity from a slowdown and value stocks are vulnerable.”
That’s not how he sees it, though. First, he believes the macroeconomic risks are already priced in, and furthermore, many of these attractively valued stocks have bolstered their balance sheets in such a way as to better cope with a potential recession.
“Investors don’t have to settle for low-quality, highly indebted or terminally declining companies to access attractively value stocks,” he said.
So where should an investor seek these value plays? MacGregor says airlines and communications are ripe for the picking at this point. Specifically, he highlighted Alaska Air Group ALK, -0.44% and Comcast CMCSA, +1.28% as two stocks worth considering.
Regardless, it won’t be easy.
“Even if a value rebound materializes, the road to recovery won’t be smooth. Volatility is likely to persist,” he wrote. “That’s why investors need to be selective. Passive value portfolios based on simple valuation metrics don’t scrutinize individual companies. To identify undervalued companies that can withstand external pressures, investors need to look closely at balance sheets, cost structures, management teams and, most importantly, cash flows as indicators of company health.”
MacGregor says investors who are patient and avoid following the heard could reap “extremely attractive” returns when the market shifts.
“Reports of the death of value investing are greatly exaggerated,” he said. “By being mindful of the current risks in the market and using multiple lenses to gauge valuations, we think investors can gain the confidence to reallocate to disciplined value portfolios based on traditional contrarian stockpicking.”
