It certainly seems like a rotten time to be a bargain hunter in the stock market.
Cheap stocks are tough to find following the market's almost-nonstop rise since the spring of 2009, and indexes covering most corners of the market are close to records. Pick any of the gauges that mutual fund managers use to measure a stock's value -- its price relative to the company's earnings, the amount of cash it generates or its total revenue -- and they're all close to their most expensive in years. Add the preference that investors have shown for high-growth stocks this year, and it has to be frustrating to be a value investor, right?
Continue Reading Below
"The premise is partially correct," says Bart Geer, portfolio manager of the BlackRock Basic Value fund.
He says "partially" because he's no longer finding stocks at close-out prices -- he hasn't seen any since early 2013. But he says there are still stocks whose prices are lower than they should be. His fund's portfolio still has close to 100 stocks, and it's still close to 99 percent invested in stocks with very little cash waiting to be put to use.
Geer and other value fund managers acknowledge that stock prices are higher than they've historically been relative to their earnings, one of the most widely used gauges of value. But they also point to how low interest rates are, and stocks have historically command higher price-earnings ratios when interest rates are low. Even with the Federal Reserve expected to raise short-term interest rates later this year, lifting off from nearly zero for the first time since 2008, many managers say they still expect longer-term interest rates to remain relatively low. That means price-earnings ratios could remain higher than they've been, and stocks may not be as expensive as they seem when compared against their historical averages.
"For value investors in high-quality companies, even if they're not as cheap as they used to be, they're still reasonably valued," says Kevin Toney, portfolio manager at the American Century Mid Cap Value fund.
— FIND BEATEN DOWN CORNERS OF THE MARKET.
Even when the Standard & Poor's 500 index is climbing to record highs, not all areas of the market are benefiting equally. The plummeting price of oil last year meant energy stocks fell nearly 20 percent from July through December, for example.
This year, worries about rising interest rates have brought down prices for dividend-paying stocks. The concern is that demand will plummet as bonds begin to pay more.
BlackRock's Geer has largely been avoiding high-yielding stocks, but this year's price drops are making him pay more attention. He still keeps less of his fund invested in utilities and other high-dividend areas than his fund's benchmark index. But he added two real-estate investment trusts to his portfolio last quarter, among other high-dividend payers.
— FIND COMPANIES IN THE MIDST OF A TURNAROUND.
Buying opportunities can be found even within areas of the market that are doing well.
Retailers and other companies that sell non-essentials to consumers have been some of the best stocks over the last year, for example. But Urban Outfitters has been an exception. Its stock tumbled 14 percent in just one day last fall after warning that its sales were tracking lower than expected.
The drop meant Urban Outfitters began trading for less than 15 times its expected earnings per share, for the first time in three years. Managers at the Becker Value Equity fund bought Urban Outfitters around then, thinking that it looked cheap given the progress the company has made in turning around its namesake brand. The stock has been volatile since last fall, jumping 30 percent in the first three months of the year but then plummeting 15 percent in one day last month.
"What you try to avoid is sacrificing quality for cheapness," says Andy Murray, a portfolio manager at the fund. "Just because something is trading at 12 times its earnings when the market is at 17 times doesn't mean it's value. It could be a trap."
— RIDE THE WAVE OF M&A
One boon for value stock funds has been the pickup in mergers and acquisitions. Around the world, companies announced $902 billion in deals in the first quarter, the best start to a year since the Great Recession.
Value fund managers are often looking for the same kinds of companies that acquirers are -- those with strong businesses and price tags that are lower than they should be -- and they're reaping the benefits.
At American Century's Mid Cap Value fund, for example, the managers can rattle off a dozen stocks in their portfolio over the last year whose shares have surged because they've been bought by rivals or had attempted takeovers, including Family Dollar and Hillshire Brands. The number was roughly half that a few years ago.