How To Invest in Value Stocks: A Turn Around May Be in Play

If you’ve been too focused on how much the high-flying tech stocks have brought down the value of your portfolio, you may not have noticed that value stocks that have been sidelined are showing signs of a turnaround. This isn’t unusual; in an economically uncertain environment, value stocks tend to do better than their growth counterparts. Not a guarantee, but something to think about as 2023 unfolds.

What Is a Value Stock?

Some people believe that a value stock is one that has fallen in value and is priced at a discount. In other words, if the price of a growth stock has fallen significantly, and you buy it at a bargain, it’s considered a value investment. That’s an extreme way of looking at it. Another, more realistic, perspective is to think of a value stock as one that’s trading at a low price relative to its fundamentals. In short, a value stock’s price may be lower than its book value, or its price/earnings ratio may be lower than that of its competitors.

Value stocks also have dividend and yield potential. And in times of uncertainty, the yield and dividends could give your portfolio some cushion. Buff Dormeier, CMT, Chief Technical Analyst at Kingsview Partners, has seen this play out in his firm’s portfolio performance. “This past year, the value factor had a 32% relative outperformance over the capital-weighted indexes, whereas the growth style underperformed by -17% in 2022,” said Dormeier.

The Benefits of Investing in Value Stocks

Value stocks tend to have lower drawdowns during market declines. The chart below displays an overlay of the iShares Russell Value ETF (IWD) and the iShares Russell Growth ETF (IWF). IWD (yellow line) has been moving up and down in line with IWF (blue line). However, since October 2022, the gap between the two has widened, with value stocks significantly outperforming growth stocks. Does that mean it’s a good time to add value stocks to your portfolio?

CHART 1: PERFORMANCE OF GROWTH VS. VALUE. On this one-year daily chart, you can see that iShares Russell 1000 Value exchange-traded fund (IWD) has moved in line with and outperformed the iShares Russell 1000 Growth ETF (IWF) for most of 2022. Since October, IWD’s outperformance started becoming more significant.Chart source: StockCharts.com. For illustrative purposes only.

Given that value stocks are relatively stronger than growth stocks, it’s only natural to think that the move could be close to exhaustion. “I believe we’re still in the early innings of this movement,” added Dormeier. “This makes a ton of sense in an inflationary environment because, with high inflation, earnings are worth less in the future, on a discounted cash flow basis. So, owning cash cow companies provides an immediate payoff, especially when earnings are returned to shareholders via dividend payments.”

The present value of a growth stock is based on future cash flows. And when interest rates are high, the future cash flows are discounted at that higher interest rate. That makes growth stocks worth less and value stocks a more attractive investment.

How Long Should You Hold a Value Stock?

Value stocks tend to be cyclical, so, if you invest in them, it’s important to be engaged with the market and ready to swap them out when the time is right. You don’t want to be stuck holding them, because it may be a very long time before they go back up.

One way to figure out how long you should hold a value stock is to look at a chart of relative performance of IWD and IWF (see chart 2). The 20-day moving average (blue line) shows the trend is still in favor of value stocks, although they are pulling back a bit. It’ll be interesting to see if it bounces back up after hitting the moving average.

Note: To add the charts to your ChartLists, just click on the chart. It’ll take you to the StockCharts platform where you’ll have the option to add it to your ChartLists.

CHART 2: VALUE STOCKS ARE STILL FAVORABLE. Keep an eye on this chart to see if there’s a bounce off the 20-day moving average. This can be a good indication of how long you should hold a value stock.Chart source: StockCharts.com. For illustrative purposes only.

Which Stocks Are “Value” Stocks?

It’s best to do your due diligence using fundamental data, but here’s a cheat sheet.

Bank stocks tend to top the list of value stocks. They kick off earnings season on January 13, so add a bunch of them to your ChartLists—Bank of America (BAC), Citigroup (C), J.P. Morgan Chase (JPM), Wells Fargo (WFC), and Goldman Sachs (GS).Homebuilder stocks are also worth considering. Some of the stocks in this category include Pulte Group (PHM), Lennar Corp. (LEN), DR Horton (DHI), and KB Home (KBH). It may also be worth adding the S&P 500 Homebuilding Subindustry Index ($SPHB) to your ChartLists.Communications network stocks are another favorite among value investors. They are known for their dividends. Stocks that fall in this subsector include Verizon Communications (VZ), AT&T (T), and Comcast Corp. (CMCSA).Semiconductor stocks are also gaining some traction of late. Micron Technology (MU), Broadcom Inc. (AVGO), and Qualcomm, Inc. (QCOM) are just a few to consider.

One of the biggest factors driving macroeconomic uncertainty is inflation. Recent comments from Fed Chairman Jerome Powell seem to have put investors at ease indicating, that inflation may be cooling, but one piece of data doesn’t make a trend. So keep an eye on the Fed’s interest rate decisions; if it sounds like it’ll take a while before inflation reaches the 2% objective, value stocks may be enjoying their ride.

How To Find Stocks With Dividends and Yields

Scroll down to Symbol Summary under Member Tools in Your Dashboard or from Charts & Tools.Enter symbol in the symbol box.Under Summary, you’ll see annual dividend and yield displayed.

The Bottom Line

Even though value stocks are outperforming growth stocks, that doesn’t necessarily mean that they generate positive returns. But because value stocks tend to have lower drawdowns during stock market declines, your losses are likely to be less than from growth stock investments. And the dividends help. So, keep an eye on macroeconomic indicators, technical indicators, and charts of value vs. growth stocks. When you see a shift in sentiment, it may be time to change your strategy.

“Long-term, growth still leads value, but, during inflationary times when interest rates are high and money supply is tight, value investments are relatively more attractive,” concluded Dormeier.

The takeaway: Losing a little is better than losing a lot.

Jayanthi Gopalakrishnan

Director, Site Content

StockCharts.com

Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.