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All Contents © 2018The Kiplinger Washington Editors
By Nellie S. Huang, Senior Associate Editor
Anne Kates Smith, Executive Editor
| July 2016
Illustration by Pablo Bernasconi
No one would mistake Wall Street for Fifth Avenue, but they do have one thing in common: As sure as hemlines rise or fall, or ties grow fat or narrow, investing styles come into and go out of fashion. This year, you’ll find value stocks in some of the smartest portfolios. As the moniker implies, value stocks are those that are cheap in relation to a company’s sales, profits or underlying assets. And for reasons that are less whimsical than the fashion dictates of Fifth Avenue, shopping in the bargain basement is paying off so far this year.
Year-to-date through June 30, the S&P Value index returned 6.2%, compared with 1.6% for the S&P Growth index. And midsize-company value funds, small-company value funds and large-company value funds occupy the top three slots so far this year among Morningstar’s nine style categories for domestic mutual funds.
Because value investors dabble in the unloved corners of the stock market, they need a steady hand and a contrarian mind-set — as you'll find at the helm of these 6 mutual funds poised to harness the power of value stocks.
All data as of June 30.
Expense ratio: 1.18%
Total return, year to date: 12.7%
One-year total return: 15.4%
Five-year annualized total return: 11.0%
Ten-year annualized total return: 7.5%
For this fund’s four managers, it’s not all about finding bargains. “We’re value investors, but we’re quality first and value second,” says Kevin Toney.
He and his comanagers start by seeking firms that generate consistent profits and cash flow, have strong balance sheets, and pay steady dividends. Only after identifying these high-quality firms do they apply value filters, using a range of traditional measures, such as the ratios of price to earnings and price to book value (assets minus liabilities). Only stocks that trade below what the
managers have determined to be the companies’ fair value get further consideration. “When you combine a value focus with companies that have sustainable dividends, and you buy when stocks are cheap, you end up with a high-quality portfolio,” says another comanager, Phil Davidson.
The fund, which has a sizable stake in preferred and convertible securities and boasts a current yield of 1.9%, delivers a relatively smooth ride. Over the past 10 years, Equity Income, a member of the Kiplinger 25, earned an annualized 7.5%, nipping the return of the S&P 500 and with 30% less volatility.
SEE ALSO: 6 Great ETFs for Owning Value Stocks
Expense ratio: 0.95%
Total return, year to date: 1.9%
One-year total return: -0.3%
Five-year annualized total return: 11.5%
Ten-year annualized total return: 8.4%
As manager Duilio Ramallo sees it, a good value stock should have three characteristics: an attractive share price; sturdy “fundamentals,” including a healthy balance sheet and talented executives at the helm; and “business momentum.” That last trait, says Ramallo, points to firms with improving results, as demonstrated by such things as expanding profit margins or rising revenues.
In reality, says Ramallo, it’s hard to find a firm that passes all his tests, so he’ll settle for just two out of three. He bought shares of Qorvo, a maker of cell-phone radio-frequency filters, in early 2016, although it had recently hit a rough patch, because it was a solid, well-run company trading at a favorable price. He will give a little on value, too. For instance, he added to his position in Johnson & Johnson earlier this year even though the stock wasn’t cheap, he says, “because it’s a great company with good momentum.” But Ramallo won’t compromise on the quality of the basic business. “It’s hard for me to stomach a crummy company, even if it has good momentum and an attractive valuation,” he says. That’s why, Ramallo says, he won’t invest in airline stocks or General Motors.
As the fund’s name implies, it can invest in companies of any size. These days, about 70% of the fund’s assets are invested in large firms; the rest are invested in midsize and small companies. Microsoft is the fund’s largest holding by market value; Sportsman’s Warehouse Holdings, a retailer of outdoor sporting goods with a market capitalization of $340 million, is among its smallest.
Ramallo, who has more than $1 million of his own money invested in the fund, took over as manager more than a decade ago, in 2005. Since then, the fund has returned 8.2% annualized, beating the S&P 500 by an average
of 0.9 percentage point per year.
Expense ratio: 0.52%
Total return, year to date: 0.7%
One-year total return: -5.1%
Five-year annualized total return: 10.4%
Ten-year annualized total return: 5.1%
This fund, a longtime member of the Kiplinger 25, can be streaky, with a run of good years followed by a couple of relatively subpar years.
Over the past 15 years, the fund’s annualized return of 6.9% beat the S&P 500 by an average of 1.2 percentage points per year. Stock benefits from its modest annual expense ratio of 0.52%, one of the lowest in the business for actively managed stock funds.
The past couple of years have been challenging for investors, says Bryan Cameron, one of the fund’s eight managers. He says he and his colleagues are aware of the big picture, but otherwise they “stick to their knitting,” which means homing in on companies with bright prospects over the next three to five years and stocks selling at depressed prices. Lately, that has led the managers to add financial-services firms, including American Express, and energy stocks, such as producer Concho Resources.
At the same time, the managers’ distaste for pricey stocks has caused them to shun utilities and telecommunications-services stocks, two of the past year’s best-performing industries. That has hurt Stock’s results. But, says Cameron, “we invest for the long term, and patience is rewarded over long periods of time.”
SEE ALSO: Best Low-Volatility Stocks for the Next Bear Market
Expense ratio: 0.81%
Total return, year to date: 7.3%
One-year total return: 1.6%
Five-year annualized total return: 8.0%
Ten-year annualized total return: 8.2%
Value investing is not just about buying when others are fearful. “It’s trying to buy the right companies when others are fearful,” says Tom Reynolds, one of the fund’s three comanagers.
With that in mind, the managers look for small, high-quality companies that are cheap by a variety of statistical measures. To steer clear of value traps (stocks that are cheap for good reason and likely to keep falling) or to avoid getting in too early, the managers dig deep into each prospective stock. They analyze a firm’s industry, its standing in the markets it serves, its competitors and trends that might advance—or retard—the company’s growth. Then they craft positive and negative scenarios for each prospective stock. “We get creative about what can go wrong, from new regulations to a plant shutdown,” says Reynolds. The range of scenarios helps them develop a risk-reward picture, as well as share-price targets based on the best- and worst-case outcomes for each stock. “The ideal stock has a 15% upside and 10% downside,” says Reynolds.
The managers’ attention to risk helps dampen volatility. Over the past three years, Small Cap Value’s 8.9% return beat its benchmark, the Russell 2000 Value index, by an average of 2.5 percentage points per year and did so with 18% less volatility than the index.
SEE ALSO: 7 Best Dividend Stocks to Buy Now
Expense ratio: 0.80%
Total return, year to date: 7.5%
One-year total return: 1.9%
Five-year annualized total return: 8.6%
Ten-year annualized total return: 6.7%
Undiscovered, unloved or misunderstood small companies that trade at undervalued prices fill this fund, a member of the Kiplinger 25. But that doesn’t mean the portfolio is loaded with “falling knives and things that look like they’re falling apart,” as manager David Wagner puts it.
A good example of the kind of stock he looks for is One Gas. Wagner picked up shares of the natural-gas utility in early 2015, after it was spun off by Oneok, which processes, transports and stores gas. At the time, One Gas was seeking approval from utility regulators in several states to earn higher profits, a process that “was going to take some time,” says Wagner. But he had confidence in the firm’s executives, and One Gas was able to win approvals in Kansas, Oklahoma and Texas. The stock has climbed nearly 60% since he first bought the shares.
Expense ratio: 0.81%
Total return, year to date: 2.1%
One-year total return: -0.8%
Five-year annualized total return: 11.6%
Ten-year annualized total return: 7.2%
Mark Finn, manager of T. Rowe Price Value, likes a good hullabaloo: “I look for relatively high-quality companies experiencing controversy. I pull them apart with my analysts and identify whether there’s an opportunity.” If the firm’s troubles are temporary, Finn subjects the company to further scrutiny to determine whether the stock is cheap enough to warrant an investment.
Finn favors stocks with price-earnings ratios and other statistical measures of value that are low relative to historical figures, both to their industry and to the overall market. Lately, he has been “poking around” in bank stocks, such as Citigroup and Morgan Stanley, whose price-to-book-value ratios are at historically low levels. Big European energy firms, such as France’s Total, the world’s fourth-biggest energy company, look attractive, too. “The major energy firms have resources and proven reserves, so they can generate cash over a longer period of time,” Finn says.
Since Finn became manager of T. Rowe Price Value in late 2009, the Kiplinger 25 member has returned 12.3% annualized. That narrowly trailed the 12.6% annualized gain for the S&P 500.
SEE ALSO: 6 Good Dividend Stocks Paying 5% or More
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