Hunting for cut-price stocks that could benefit from a value revival

Is value investing making a long-awaited comeback?

There have been signs this autumn that after nearly a decade in the doldrums, one of the most tried and trusted stock market strategies is starting to work again. Value investing – the part-art, part-science approach to buying shares when they’re marked down – has flickered into life on both sides of the Atlantic.

For weary value investors, the headlines are a welcome relief. But after an unusually long spell of underperformance, it’ll likely take more concrete proof to convince many that the market really is turning a corner.

While everyone knows that value strategies suffer lapses in performance, a 10-year hiatus has been a tough test for even the most devout followers of Ben Graham (the father of value investing).

In that time, the expansionary effects of cheap money and central bank stimulus has washed through the economy and spilled across the stock market. Confidence has surged and growth stocks have benefited most. Meanwhile, those beaten, broken, unloved and unsupported value stocks have been left on the sidelines.

The trouble with value

When value works, the principle of owning mispriced stocks until the market catches on and corrects them can pay off handsomely. But when value falters, buying cheap stocks means tip-toeing around traps, dodging disasters and waiting endlessly for a change in sentiment.

Despite the pain, there are good reasons why so many investors define themselves as value-oriented. For a start, value is probably the most heavily researched, professionally tested and best understood investment strategy around.

It’s also got a very solid recent record of blowing other strategies out of the water. Two memorable examples – the periods after the tech collapse in 2000 and the financial crisis in 2009 – saw value stocks roar to life. Fortunes were minted, and reputations cemented – and that’s been an important comfort for those waiting for its comeback.

Earlier this month, Cliff Asness, the well-known quant-value, billionaire-boss of the hedge fund AQR Capital, wrote a note he’d probably been wanting to write for some time. Like other pro investors with a value bent, some of Asness’s funds have suffered in recent years.

In it, he wrote that the first eight years of value’s recent 10-year losing streak were “rational”. In other words, value just didn’t look that cheap. But in the past two years things have changed. Value has been a losing strategy for “irrational” reasons. Stocks have started to become cheaper but that isn’t yet reflected in their share prices.

What does this mean? Well, for Asness, who always warns against trying to time the market, these are signs that 1) value isn’t dead (although it’s still out of favour), and 2) there might be an opportunity here.

For Asness at least, it could be time to “sin a little” and increase exposure to value. For now, this is as close as a “call” that you’ll get that value investing is ready for a revival.

Screening for value

So what might be cheap? Value investors all have differing preferred measures of cheapness, and the risk of buying a value trap (where the price continues to fall) is ever-present. This table focuses on £1bn-plus stocks and grabs some common value metrics, including the forward price/earnings ratio and dividend yield, as well as Stockopedia’s composite Value Rank (where 100 is cheap and 0 is expensive).

Also included is the StockRank Style, which captures the exposure of each share to the three stock market factors of Quality, Value and Momentum:

Super Stock = High exposure to quality, value and momentum
Contrarian = High exposure to quality and value, but low momentum
Value Trap = High exposure to value, but low quality and momentum
Neutral = No strong positive or negative exposures

The list is sorted in order of the number of guru-inspired value investing strategies that each stock currently passes the rules for.

Housebuilders almost always look cheap because the market hates their highly cyclical nature. Stocks like Redrow, Barratt and Bovis have performed well over five years. They are solid, profitable businesses that pay out robust dividends and have the benefit of government efforts to promote home purchases. But that support may end, and that makes this a volatile sector.

In the same way, others, like the traditional tobacco groups Imperial Brands and British American Tobacco are in the “value” bucket because of their “sin stock” status. Changing industry trends have buffeted their businesses. Similar types of uncertainty and cool sentiment hang over stocks ranging from the oil industry players BP and Petrofac to the beaten down telecoms giant, BT.

A change in market direction?

There would be nothing that many investors and fund managers would like to see more than a resurgence in value strategies from here. With the Samp;P 500 breaking 3000 points and reaching new highs this month, the market backdrop in the States seems far from bearish. And as Seth Klarman, the value investing boss of Baupost, once noted:

“… value investing is not designed to outperform in a bull market. In a bull market, anyone, with any investment strategy or none at all, can do well, often better than value investors.”

In the UK, the situation is a bit different. The main FTSE 100 and 250 indices have trended up in 2019, but making sense of what’s going on in the face of Brexit uncertainty makes interpreting this tricky. It could be the case that a Brexit discount is baked in. If so, any lifting of the fog of uncertainty could add extra impetus to a shift in interest towards potential value stocks.

Stockopedia