Value back in vogue

As money managers and investors continue to bid up stock prices, value investing is slowly coming out of its five-year hibernation, too.

In fact, 2012 showed again that in the long run a value investor proves to be the tortoise in a hare’s race.

For the first time since 2008, value stocks are now outperforming their growth-oriented, costlier counterparts,reports FT.com.

Read: How to use active investing to outperform

As a result, mutual funds comprising large value stocks attracted $2.4 billion in January. That’s because lower valuations make them safety valves during market crashes.

A major pullback in equities also creates an opportunity for value people to pick stocks from the more dominant parts of the index at deep discounts.

Style matters, too. The fundamental need for underpriced stocks compels value managers to adopt more active strategies.

And value stocks with low price-to-earnings and price-to-book-value ratios outperform growth stocks in both Canada and the U.S, contends George Athanassakos, a professor of finance and the Ben Graham chair in value investing at Richard Ivey School of Business.

Read: Top analysts reveal market opportunities

“They outperform when the markets go down and when they go up,” he wrote in a 2012 journal article. “And they do all this without having higher risk.”

Contrary to what the detractors say, there’s more to value investing than identifying undervalued stocks. You’ve got to screen for the right sectors.

Sectors that dominate benchmark indexes are often vulnerable to volatility, and unsuitable for this style of investing.

Noted value manager Charles Brandes of Brandes Investment Partners says small companies in sectors that aren’t major parts of an index get overlooked and become undervalued.

“Skilled active managers can exploit this excessive undervaluation and identify companies likely to produce better returns,” he said at a presentation in Toronto last summer.

Outperformance is the result of a rigorous sector and stock-selection process, not of market timing, asserts Athanassakos, adding the portfolio manager’s skill brings about greater returns.

Getting sector selection right can also eliminate the need for diversification.

“Value investing is all about concentrating a portfolio to a few selected truly undervalued stocks,” says Athanassakos.

Read: Lessons in value investing

But separating good bargains from bad requires patience.

Superior returns can be earned only by those who stay put, advises this WSJ.com report.

After bad years, panicked investors tend to bail out, like many did in the late 1990s, and miss out on rallies in later years. More importantly, the report argues, value stocks are no longer as cheap as they once were.

To present a counterpoint, it draws from a study that points out: “Historically, they averaged 54% cheaper than growth stocks, as measured by prices relative to earnings. Today, value is 40% cheaper.”