Finding values everywhere
Value stocks tend to outperform growth stocks over long periods of time, but that doesn’t mean you should dump your growth stocks.
According to Morningstar, value stocks delivered an annualized return of 11.4% from 1969 through 2007, versus 9.2% for growth stocks. But growth stocks have set the pace for a number of multiyear stretches, and at this time they appear to have stronger fundamentals than value stocks.
Components of the S&P 1500/Citigroup Growth Index average a Quadrix Overall score of 65, versus 51 for components of the S&P 1500/Citigroup Value Index. While the Quadrix data suggests growth is more attractive than value, keep in mind that the distinction between growth and value tends to be arbitrary. Different people and organizations use varied criteria to classify stocks as growth or value.
Fortunately, you don’t need to know whether a stock is “growth” or “value.” Just look for good values, no matter where you find them. While the growth index’s average Quadrix Overall score is higher than that of the value index, components of both indexes average the same Quadrix Value score — 57.
The average S&P 1500 stock trades at 12 times trailing earnings and at a discount of 46% from its five-year average P/E ratio. Those numbers suggest the market is packed with “value” stocks, though not all inexpensive stocks represent appealing values.
Value investors should even consider stocks in sectors normally the purview of growth investors. The average consumer-discretionary stock trades at 12 times trailing earnings, while the average technology stock sports a P/E ratio of 13.
To identify attractive values, start with the Quadrix® Value score, which considers both current ratios and values relative to historical norms. For example, the Value score looks at the trailing price/sales ratio, as well as the current prise/sales ratio divided by the three-year and five-year medians.
Stocks with high Value scores tend to outperform the average stock, as shown in the chart below. The chart also identifies six valuation ratios with particularly strong predictive power.
Two stocks with high Value scores and low numbers for several key valuation ratios are reviewed below:
National Oilwell Varco ($25; NYSE: NOV) has fallen victim to broad-based sector weakness. The stock is down 65% so far this year despite solid operating results and expectations for excellent profit growth. Summer’s wild assumptions about oil reaching $200 a barrel have given way to fears of a devastating global slowdown. Oil prices have plunged, and National Oilwell has fallen with the pack. Now trading 13% below book value of $29.38 per share and five times expected year-ahead earnings, the stock represents a tremendous value.
Oil prices remain high relative to historical norms, and consumption is still expected to increase in 2009 — just not at the frenzied pace predicted earlier this year. As long as oil prices recover to settle above $65 to $75 per barrel, we expect most producers to continue drilling — good news for National Oilwell, which sells and services equipment for drilling rigs.
In the September quarter, National Oilwell earned $1.35 per share excluding merger-related charges, up 30% and $0.04 above the consensus estimate. Revenue rose 40%. The backlog of capital-equipment orders rose 9% to $11.8 billion. Consensus estimates project the company’s per-share profits will rise 33% in 2008 and 5% in 2009. Per-share profits have more than doubled since the last time National Oilwell traded at current levels. National Oilwell Varco is a Buy and a Long-Term Buy.
Over the last five years, Western Digital’s ($14; NYSE: WDC) earnings per share rose at an annualized rate of 35%, with revenue growing at a 24% clip. In the September quarter, Western earned $0.93 per share, up 18% excluding charges in the year-earlier period and $0.12 above the consensus. Revenue jumped 19%, powered by a 34% increase in unit shipments. The company projects per-share profits of $0.80 to $0.90 in the December quarter, well below the $1.35 earned in the year-earlier period. But at five times Wall Street’s profit expectations for fiscal 2009 ending June, and with a Quadrix Value score of 98, the hard-drive maker looks enticingly cheap.
Western’s strong product pipeline should help offset declining profit margins for computer storage, boosting revenue and increasing exposure to markets with higher margins. The company is rapidly expanding into the high-growth market for notebook computers and mobile devices, such as digital recorders. Storage for devices other than desktop computers generates 56% of the company’s sales, up from 29% three years ago, a percentage likely to increase over time.
At the end of September, the company held $1.21 billion in cash, or more than $5 per share, enough to pay off its long-term debt more than twice over. Western Digital is rated Buy.