Value investing in a unique cycle

As growth stocks continue to outperform, investors might be wondering where value stocks fit in their portfolios — and when the tide will turn in favour of value.

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“Since the financial crisis, growth has outperformed value virtually every year,” said Peter Hardy, senior client portfolio manager of global value strategies at American Century Investments, in an Aug. 22 interview. “The magnitude of the outperformance of growth as a style versus value as a style is historically significant.”

The Russell 1000 Growth Index, for example, has outpaced the Russell 1000 Value in all but three of the last 10 years ended in 2018. And for the 10-year period between year-end 2008 and year-end 2018, $10,000 in growth stocks would have earned more than 314%; value, about 188%.

Yet, historical data for the Russell indexes also shows that, over 10-year periods, value outperforms growth 62% of the time (based on rolling periods from 1979 to 2018), which helps put the growth-value dynamic in perspective. Also, the current dynamic is often characteristic of market peaks, Hardy says.

Another unique market characteristic is that, over the last five years, low-volatility and high-yield names have also outperformed, says Hardy, whose team manages the Renaissance U.S. Equity Income Fund.

Incorporating these observations into his investment strategy, he defines his current portfolio positioning to find value as “DARP”: defensive at a reasonable price. The key to this process is identifying companies that are high-quality, low-volatility dividend producers, he says — “and also cheap from a valuation perspective.”

He adds that his team has always earned returns by “identifying the best values within our universe of quality businesses, layering in non-common securities to further open up our opportunity set, and utilizing income as a way to further diversify.”

In this way, the portfolio does well during up markets and protects on the downside, he says.

Defensive at a reasonable price

One area that fits Hardy’s investment strategy is financials.

“In 2008, we were very underweight banks,” he says, due to their increased leverage and overvaluation. Banks have since recapitalized and are underearning due to low rates, making them undervalued, he says.

His portfolio has exposure to large banks such as Wells Fargo, JPMorgan Chase and PNC Financial Services. Hardy says that, in addition to underearning on their spread incomes, the names have fee-related businesses to diversify returns, and are well capitalized with attractive valuations.

A “thrift” bank that Hardy’s team likes is Capitol Federal Financial, located in Topeka, Kans. “It’s one of the best-capitalized banks in the country,” he says, and pays a 7.2% special dividend.

A second sector where Hardy finds DARP names is healthcare.

He says concerns about a potential national health insurance plan in the U.S. have put pressure on these stocks, but the concerns are overstated considering the challenges that such a proposal faces in Congress.

His team holds Johnson & Johnson, which he describes as a high-quality name with a great med-tech business. “They spend the most out of any pharma company to maintain their market leadership by investing billions of dollars in R&D,” he says, which has resulted in products in immunology and oncology.

The company has been hit with numerous lawsuits due to the sale of products containing talc and opioids. Most recently, Johnson & Johnson was ordered to pay $572.1 million to the state of Oklahoma, but that amount was less than investors had expected.

The legal action hasn’t hurt the company’s stock. This week it was trading above US$130, higher than where it started the year after peaking around US$144 in June.

“J&J has never had a big settlement in pharma,” Hardy says. “This stock is cheap for a variety of reasons, and is one we own in the current market environment.”

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