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Late to the Rally? Bet On Value Stocks

An odd thing happened on the way to financial oblivion last year. Stock that started off cheaper than the broad market performed much worse than ones that didn’t.

Value investors, as people who favor such inexpensive shares are called, understandably expected them to lead the market in 2009. Incredibly, they’ve continued to lag well behind — until just the past few weeks. So are value stock finally ready to soar?

Let’s first define the terms. “Growth” and “value” are wishy-washy descriptors, since all companies are meant to grow, and since just about any stock ticker that will be worth more tomorrow is something of a value today. I prefer the terms “popular” and “unpopular.” Generally speaking, growth stocks are popular. They fetch prices equal to many times their current profits or asset values, on the assumption that their profits or asset values will grow quickly in coming years. Value stock are less popular. They trade at lower multiples of their profits and asset values because they’re not expected to grow as quickly.

There are no firm numeric cutoffs.  Stock exist in a spectrum between growth and value, not on either side of a fence. Hence, mutual funds and stock tickers indexes labeled as growth and value often hold or track the same stock . To get a clear read on how the two styles are performing, focus on benchmarks that have no overlap, like the S&P Pure Growth and Pure Value indexes. Last year, Pure Value lost 48%, while Pure Growth lost 39%. This year through April, Pure Value lost just under a percent, while Pure Growth gained 10%.

That’s not normal. In past market downturns — from December 1980 to July 1982, from September 1987 to November 1987, from September 2000 to September 2002 — value stock  outperformed. They trade with less popularity, after all, so they have less of it to lose when stock as a class lose luster. But value stock are often cheap because of company flaws that, while perfectly manageable in a normal market downturn, can turn disastrous in a global financial flush like the one that began in earnest last fall. Investors during the worst bits of the past year stopped asking about the return on their money and started asking whether they will ever see a return of their money, reckons Robert Arnott, whose firm, Research Affiliates, manages indexes that skew toward value stock

A close look at the numbers suggests value stocsk might have recently broken free of the abuse. While they’ve trailed year-to-date, the damage happened early when the market was falling. Through May 9, the S&P 500 index dropped 25%. Pure Growth lost only 20%, while Pure Value plunged 44%. In April, when stock rose, just the opposite: Pure Growth gained 15%, while Pure Value soared 32%.

Below are listed a handful of members of the S&P 500 Pure Value index that still seem attractively priced.

Screen Survivors
Company Ticker Industry Share
Avery Dennison AVY Paper products $28.42 11 5.8
Big Lots BIG Discount stores 28.35 15 n/a
Consolidated Edison ED Utility 37.36 12 6.3
McKesson MCK Drugs 39.11 10 1.2
Verizon Communications VZ Telecom 31.04 12 6

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