Mellody's Math: Stick to Your Values

The best way to look forward to the investment landscape of 2002 is to start by looking back.

Value investing was not always in vogue, yet history has proven that it is not just a passing fancy, but a tried and true investment philosophy that has withstood the test of time.

For the one-year period ended Dec. 31, 2001, the Russell 2000 Value Index, measuring the performance of smaller, value-oriented stocks, was up 14.02 percent. This double-digit return is even more impressive when compared to the performance of the overall market, as measured by the S&P 500 Index, which fell 11.89 percent.

After years of relative underperformance and a low profile on Wall Street, value investing has finally given its growth counterpart a run for its money.

History Tells the Tale

The story was drastically different two years ago. The beginning of 2000 marked the proliferation of dot-coms and IPOs were at an all-time high. Scads of investors had jumped ship from their mutual funds, perceiving professional management as an unnecessary albatross.

Combine this "show me the money" mentality with the year's unprecedented economic conditions — the stock market selling at all time highs and a bull run that outlived any other — and any true contrarian investor could tell you that investors were in for a jolt of reality.

Like hem lines and boy bands, stocks market darlings can have a short-lived time in the sun.

And then March of 2000 came in (and out) like a lion, knocking the so-called "new economy" phenoms back down to Earth, and rewarding patient value investors with positive returns for the first time in years.

And so it seems, with the new millennium came new stock market leadership — an about-face from 1999, when traditional value managers were practically annihilated by a "new economy" stock rally and publicly scorned for clinging to time-tested (derided as "old") investment principles.

Investor's Playground

Hindsight is 20/20, but dedicated value investors can look back at the market euphoria of the late 1990s and see where the dot-coms showed fundamental lacks — lack of earnings, lack of seasoned management, lack of providing a quality product or service.

These are basic requirements when selecting a stock for purchase, and they are also the tenets of value investing. So many investors scorned these "unnecessary details" as archaic methods of stock analysis, hardly applicable in our new tech-savvy markets.

A natural contrarian's confidence is heightened when they see such widespread like-mindedness. "If all children sit on one end of a seesaw because it's the end going up, it can't go up." In purchasing shares of companies that have been widely ignored by Wall Street investors, the patient investor has got a seat on the side of the seesaw that is ready to rise.

And rise it did in 2001. Value investors were rewarded for their patience and disciple, as undervalued stocks were insulated from the looming recession, rising unemployment and earnings disappointments.

Buy low — so simple in concept, so difficult in execution. Prices are low when demand is low. And demand is low when confidence is low. As such, despite the falling consumer confidence and a vacillating market, dedicated contrarian investors were not discouraged and recognized that times of dramatic market sell-offs are when value investors earn their pay.

Defining Value

When looking for a quality investment, it is important to remember that "value" and "cheap" are not synonymous.

Look for financially strong companies with strong balance sheets and track records of success. Look for distinct products and services. Look for seasoned management that holds a personal financial stake in their firms, thereby inextricably linking their interests with those of their shareholders.

In today's world of hot stocks, mega-mergers and professional managers, these CEOs are a rare and precious breed.

Given today's economic uncertainty, readers should not be too surprised to see another shift in the value/growth paradigm. But remind yourself to be a long-term investor. Value investing will likely fall out of grace on Wall Street several more times in our lifetimes, but the true test of the contrarian investor is to have the dedication and patience to stay on the roomy side of the seesaw.

A Few Value Choices

Here are some of my own value picks for 2002:

My favorite companies are those with strong brands, long track records of growth and consistent earnings. Consider furniture manufacturer Herman Miller. The company's progressive employment practices and state-of-the-art office furniture rank it as one of the best companies in America. With its popular ergonomic Aeron chair, this stock could be sitting pretty in 2002.

Another company potentially worth adding to your portfolio is Lee Enterprises. Lee owns 23 daily and more than 100 weekly newspapers in small and medium-sized markets throughout the Midwest and Northwest. As the newspaper industry continues to consolidate, Lee would be an attractive takeover candidate, which would have a very positive effect on Lee's share price.

One additional company worth considering is ServiceMaster Company. The company has "mastered" the art of providing housecleaning, pest control and landscaping services to more than 12 million customers around the world. The company's best-known brands include Merry Maids, Terminix and TruGreen ChemLawn.

Mellody Hobson, president of Ariel Capital Management in Chicago, is GoodMorning America's personal finance expert. Click here to visit her Web site, Ariel Mutual Ariel associates Matthew Yale and Anne Roche contributed to this report.