Way back in the late Jurassic period, when you could buy a comic book for less than $5, you could also buy X-ray Specs for just $1. X-ray Specs would have been a great value, except they didn't really let you see through solid objects like Superman.
As a generation of deeply disappointed boys discovered, "value" isn't the same thing as "cheap." They fell into the value trap. For something to be a great value, it has to be something you can buy for less than you'd normally expect to pay.
Given the stock market's dreadful performance this year, you might expect that you can now find great bargains. You'd be right. And some of the best bargains may be among the funds that do the searching for you.
Value investing means buying stocks cheaply, in the hope that eventually they'll rise to their intrinsic value. It's a time-tested strategy: Large-company value funds have gained an average 9.9% a year over the past 15 years. Large-company growth funds, which seek out companies with bright earnings prospects, have gained an average 8.4% over the same period, according to Morningstar, morn the investment trackers.
But value investing isn't the stock market's equivalent of the Northwest Passage — a quick shortcut to riches. Value endures bad years, too, and last year was one of them. Large-company growth funds soared an average 13.4% last year, compared with a 1.5% gain for large-company value funds.
Financial services stocks were the biggest value traps last year. Value funds are often attracted to financial stocks, because they often have low price-to-earnings ratios. (The price-to-earnings ratio is a stock's price divided by its past 12 months' earnings. Lower is cheaper.)
The typical large-company value fund has 23.8% of its assets invested in financial services stocks, vs. 9.8% for the average growth fund.
Bank stocks looked cheap in the summer, but they still weren't a bargain. Citigroup, c for example, closed at $47.90 on the last day of July, down from $55 in mid-May. Back then, Citi sold for 12 times earnings.
A bargain? At $25, Citi certainly looks appealing now. But its P-E is 37 — nosebleed territory, particularly for a bank. That's because even though Citi's price dropped, its earnings fell much more, thanks to its subprime losses.
Some would argue that, using current earnings estimates of $3.12 a share for 2008, the company is a bargain at just eight times earnings. Should those estimates pan out, then Citi is indeed a bargain. But accurate earnings forecasts for gargantuan banks are elusive; major international banks are complex creatures.
"We spend more time talking about financial (stocks) than anything else," says Eileen Rominger, manager of Goldman Sachs gs Large-Cap Value fund. "Every line on their balance sheets represents a degree of estimate."
Though you can start your search for value with beaten-up stocks, or stocks with low P-Es, that's just the starting point. You also need to consider:
•Debt. A company with a high level of debt can't survive a downturn as well as one with low debt.
•Earnings. No one wants to buy a stock that doesn't have earnings or the potential to grow earnings, notes James Cullen, manager of Pioneer Cullen Value. cvfcx "You want to buy growth at a value price."
•Management. "They all have good game plans and vision," Rominger says. "The best clue you have to how good management is, is by looking at how they have spent shareholders' money over time."
In other words, has the company been reinvesting its earnings into its most productive business lines?
If you feel that picking bargains yourself is too difficult, consider investing in a fund that aims for value. The five large-company value funds with the best five-year records are in the chart.
You might also consider a closed-end value fund. These funds trade on the stock exchanges, just like stocks. Unlike most mutual funds, however, a closed-end fund's price rarely reflects the actual value of its holdings. Instead, it signals investors' opinion of the fund's prospects. And when investors are pessimistic, you can often find some real deals.
Consider Gabelli Dividend & Income Trust gdv. Its holdings are worth $21.41 a share. But its share price is $18.39 — or about a 14.1% discount. Were the fund to liquidate and distribute the proceeds to shareholders, they'd get a $3.02 profit per share.
Because the fund is a value fund, it's presumably buying bargain stocks — which you, in turn, are receiving at a discount. Other similar funds are Dreman/Claymore Dividend & Income (DCS), dcs BlackRock Strategic Dividend Achievers bdt and MFS Special Value Trust mfv.
True bargains may indeed require a form of X-ray vision. But these funds, at least, are one easy place to start your quest for value.