How to Win the Value Stock Waiting Game

Inside the contrarian strategy of buying and holding stocks that others shun.

ByABC News
July 7, 2016, 9:12 AM
Warren Buffet participates in a discussion during the White House Summit on the United State Of Women June 14, 2016 in Washington. The White House hosted the first ever summit to push for gender equality.
Warren Buffet participates in a discussion during the White House Summit on the United State Of Women June 14, 2016 in Washington. The White House hosted the first ever summit to push for gender equality.
Alex Wong/Getty Images

— -- Often in stock investing, the spoils go to those who wait.

Such is the case with value stocks: companies that have solid fundamentals but depressed share prices.

The share price may be depressed because a company may be in a boring industry that few analysts follow, so investors can’t get much information. Or perhaps there are questions about a company because of known negatives. Think falling oil prices and poor performance by energy stocks in the last year or two. For whatever reasons, the market isn’t confident in value stocks, so the shares languish.

Value investing is the strategy of buying what investors perceive to be undervalued stocks and waiting for the time when everyone begins buying. Meanwhile, value stocks often pay higher dividends to attract investors, which eases the waiting.

Whether a particular value stock is a good investment depends on how long the investor is willing to wait for share-price growth. For the past several years, value stocks performed poorly while growth stocks have done quite well. Growth stocks are those that are highly valued by the market because their near- and long-term prospects for good performance are viewed as promising. Some of today’s value stocks are yesterday’s growth stocks and vice-versa.

Value stocks wouldn’t be value stocks if they were always doing well. In that event, they’d be growth stocks. But the strategy of value investing has good periods and bad. Growth stocks have outperformed value stocks for most of the past decade and a half. But value was the winner in the decade and a half before that.

Buying value stocks is a form of contrarian investing -- going against popular market trends that drive up the share prices and the price/earnings (P/E) ratio.

Contrarian investing is often based on the idea that the market pendulum has swung away from certain kinds of investments and will eventually swing back—a concept supported by decades of market history showing that the pendulum has done just that.

In the first quarter of this year, value stocks showed early signs of a potential comeback. By contrast, key growth stocks had a lackluster showing. Because of this early 2016 performance and other factors, some well-regarded market analysts believe that more value stocks will be rising significantly in the coming months.

Value investing is for the patient. And this is an impatient market, driven by news events like Brexit. Big institutional traders are looking to turn a quick buck on daily or hourly gyrations.

But for those willing to buy low and hold for years waiting for share-price gains, value investing is a proven method—a haven from the day-to-day gyrations. While many of today’s churn-and-burn investing stars shun value investing, many household names – most notably, Warren Buffett -- have become fabulously wealthy this way.

Value investing strategies have been around for decades. The founding fathers of this method, Benjamin Graham and David Dodd, published their now-classic book on value investing, Security Analysis, in 1934. Now required reading in most business schools, this volume has become the bible of value investing.

A good way for most individual investors to own value stocks is to harness the convenience, flexibility and broad diversification of exchange-traded funds (ETFs) which, like index funds, are pooled investments where investors buy shares to own little pieces of many companies. Value stock ETFs come in all flavors – large, medium and small companies. But usually, to get the highest and most reliable dividends, large cap ETFs are the best way to go. These investments usually pass the dividends paid on the stocks owned along to fund shareholders quarterly on a pro rata basis. The more ETF shares you own, the higher your dividend payments.

There are many value ETFs to choose from and you can find a list of the top performers here. Look for ETFs with at least $1 billion in assets and low expenses—many of the Vanguard ETFs have expense ratios below 0.10.

Historically, value stocks have been good investments prior to periods of accelerating economic growth. So those with confidence in the economy’s near-term prospects might want to invest in the stocks that tend to benefit sharply from this growth, including heavy construction equipment, mining (for raw materials used in construction) and retailers that rise with increased consumer activity.

To the extent that stock market performance affects the economy, value stocks are in a good position, despite the recent hand-wringing and market volatility stemming from Britain’s vote to leave the European Union, and to some degree, because of it. As Brexit has roiled European markets, U.S. markets, already a haven for global investors, are likely to be seen as even more desirable.

This tide will likely raise all boats somewhat—including value vessels. But for significant increases in value stocks, you must wait for them to come back into favor relative to other companies. It will happen; the only question is when.

Dave Sheaff Gilreath is a founding principal of Sheaff Brock Investment Advisors LLC. He has more than 30 years of experience in the financial services industry.

Any opinions expressed in this column are solely those of the author.