Value investing involves the investment strategy of finding quality shares that are believed to be undervalued in the market by using an approximation of the stock’s value. The stock’s value (its worth) is based on the performance of the company and a view of its future sustainable profitability, also called normalized return on equity. Companies that are temporarily out of favor, or flying below Wall Street’s radar, may offer strong growth potential if they rebound. The key is to find the companies that appear to be attractively priced before the general market recognizes them.
1. What is the outlook for value investing for 2017?
We believe the outlook for value investing, particularly among U.S. large-capitalization stocks, is quite positive for 2017. We believe U.S. equities should benefit from a combination of near 10% earnings growth and a 2.1% dividend yield, resulting in a total return between 8% and 12%. We think value stocks are particularly attractive among large-cap stocks and offer opportunities for outperformance relative to the broad U.S. equity market.
Why does value investing make sense now?
Growth stocks have been leading the market since the Great Recession — until 2016. This cycle began to favor value in 2016, value outperformed, and we believe this period of value dominance will persist. Additionally, certain sectors and securities may offer attractive opportunities due to current valuations being attractive, good fundamentals and accelerating earnings. Our research-driven, fundamental investment process seeks to identify these opportunities, and we heavily weight them in our portfolio.
2. Why should investors consider a value component in their investment portfolios?
Investors need attractive returns to meet their retirement and savings goals, and we believe a diversified value portfolio should be the cornerstone of an equity portfolio, where appropriate.
3. What is the process your team employs to identify undervalued companies?
Common to every stock we own is some level of market skepticism, which allows our three selection characteristics — attractive valuation, good fundamentals and a catalyst for business improvement — to coexist in a company. We strive to identify companies that offer a compelling catalyst or encouraging leading indicator that is not yet fully appreciated by the market or those that exhibit earnings momentum with an unwarranted high level of investor skepticism.
We use traditional measures of value to screen for relatively inexpensive securities. We seek securities that exhibit low price/book, price/earnings, price/normalized earnings, price/cash flow and price/sales ratios. Specific emphasis on one metric over another depends on a multitude of factors, including sector, business-cycle phase, industry practice and company-specific circumstances, among others.
We also analyze company financials very closely, focusing on revenue growth, earnings growth, balance-sheet strength and related changes, liquidity and free-cash-flow generation. We are attracted to high-quality management teams, beneficial supply/demand dynamics, product-cycle stories and favorable competitive environments.