Value Investors are caught between a rock and a hard place. Valuations are rich—they have been rich, but the market continues to go up!
With the forward P/E multiple hovering around 17 or 18 for the S&P 500, and the FANG stocks (Facebook, Amazon, Netflix and Google) continuing to drive the overall returns of the market, where do you go for investable ideas?
My Grandmother was a knitter. She knitted sweaters, mittens, caps, Christmas ornaments. We only have to look at our Christmas tree to be reminded of her. Later in her life, she would visit the doctor and complain that her eyesight was making it very hard to continue her favorite hobby. After looking at her eyes, the doctor would turn and say that there wasn’t anything to be done, and that she would just have to work harder . . . and that is what I would say to Value Investors, they just are going to need to work harder.
Value Investors typically look for stocks that have fallen out of favor, and/or are underpriced in wview. This usually means that they have a lower Price/Earnings Multiple (P/E). The P/E is a ratio created by dividing the Price per Share with the Earnings per Share to create a number which basically answers the question: How many dollars would you pay for a dollar’s worth of earnings from this stock? The P/E multiple for the market hovers anywhere between 12 and 20, with 15 being the normal average number. P/E’s tend to go up when investors see more growth prospects on the horizon.
How Value Investors Can Find Stock Ideas
Value investors know that they will miss out on the high-flying stocks like Netflix and Tesla which are being priced at incredibly high P/E Ratios. But right now, the vast majority of stocks are over their P/E comfort level. So where can an investor find stocks with a low P/E but solid prospects? I did a quick screen looking for Bullish stocks with low Price to Book, and Price to Earnings ratios. There were some useful observations:
Smaller stocks cropped up more than the larger stocks. This indicates that the S&P 500 stocks have garnered much of the attention over the past two years, leaving their smaller brethren behind. There look to be some really interesting small cap stocks.
Several industries also popped up frequently. Financial stocks still are working their way back from the 2009 debacle. While their prices have risen in the past year, so have their earnings, so comparatively, they are still undervalued (Examples are Hope Bancorp, BCB Bancorp). Retail and Restaurant stocks have been shunned over the past two years, and there are a few really solid companies that have been overlooked (Fogo De Chao, Best Buy). There are some stalwarts in the Industrials (Briggs and Stratton for instance).
In summary, value stocks are still available but you have to look more carefully. Smaller rather than larger stocks. Industrials, Banks and Retail represent some of the better stocks that have low P/E and Price to Book multiples. You can still knit together an impressive portfolio as long as you put in the work!