The Right Spot For Value

8/29/2016


Over the past 12 months, value stocks in the broad Dow Jones U.S. Index have averaged a 13.5% total return, versus 6.8% for growth stocks. Dow Jones categorizes a stock as growth, value, or neutral (a mix of growth and value) based on trailing and projected earnings growth, P/E ratio, price/book ratio, and dividend yield.

Value stocks could continue to lead if investors keep flocking to income plays that offer a defensive slant. Dividend payers among value stocks in the Dow Jones U.S. Index yield 2.7%, compared to 1.4% for growth stocks. Notably, 371 of the 532 value stocks yield more than 2%, versus only 63 of the 460 growth stocks.

Value stocks tend to be less volatile than growth stocks. Consider beta, which measures sensitivity to stock-market movements. Value stocks have a median beta of 1.0, which matches the broad market. In contrast, growth stocks have a beta of 1.2, implying 20% more volatility than the market. 

While the number of stocks with bargain-basement valuations is relatively low, you can still find pockets of value. Keep the following points in mind when shopping:

• Value is in the eye of the beholder. Our studies typically consider value stocks as those ranking among the cheapest 20% based on the Quadrix Value score, the most important of the six category scores based on research back to 1994. Today, only 129 of the 532 "value" stocks in the Dow Jones index earn Quadrix Value scores of 80 or higher. That said, top Value scorers in Quadrix have underperformed in 19 consecutive rolling 12-month periods. The Quadrix Value standouts are far more concentrated in truly cheap stocks, and the cheapest stocks as measured by nearly all valuation ratios (except yield) have done poorly over the past year. Also, Quadrix Value scores don't consider growth rates, while Dow Jones value stocks have benefited from this year's outperformance in shares of low-growth companies. Fortunately, history suggests that a shift toward top Quadrix Value scorers is overdue.

VALUATION SNAPSHOT
Among value stocks, some Dow Jones U.S. Index sectors look cheaper than others. Based on the number of value stocks with Quadrix Value scores above 80, standout sectors include consumer discretionary and financials. Those sectors, along with technology, also have modest forward P/E ratios.
------- Quadrix Value Score -------
Number Of Stocks
----- That Score -----
------------ P/E Ratio ------------
Sector (Number Of Companies)
Current
Above 80
Above 50
Trailing
Est. Curr.
Year
Est. Next
Year
Consumer discretionary (58)
76
26
47
15
14
13
Consumer staples (31)
35
3
6
23
22
20
Energy (32)
42
7
13
11
19
21
Financials (190)
64
53
119
16
16
14
Health care (22)
54
3
12
18
17
16
Industrials (47)
55
9
30
18
19
17
Materials (32)
60
5
20
18
18
15
Technology (60)
58
16
38
16
16
14
Telecom services (6)
66
1
5
14
13
13
Utilities (54)
51
3
27
20
20
18
DJ U.S. value stocks (532)
56
126
317
18
18
16
Notes: Quadrix scores are percentile ranks, 100 the best.    P/Es below 0, above 75 excluded.

• Based on the number of stocks with P/E ratios below five-year norms, insurance, banks, retailing, and real estate offer fertile ground for bargain hunters.

• Industries with a meaningful number of stocks with Quadrix Overall scores above 80 and attractive yields include auto parts, insurance, banks, and technology hardware.

• Seven groups are expected to increase per-share earnings at least 8% both this year and next year: consumer durables, consumer services, food & staples retailing, food & beverage, drugs, semiconductors, and software.

Below we review five of our favorite value plays. All five earn Value scores of at least 80 and are expected to grow sales and earnings this year and next.

Uncertainties weigh on Alaska Air Group ($68; ALK) shares, partly relating to its pending $2.6 billion acquisition of Virgin America ($56; VA). Detractors point to the deal's hefty premium, integration risks, and possible credit downgrade. Virgin America also has lower profit margins than Alaska Air, which has seen its shares slump 14% since announcing the deal on April 4.

The shares trade at nine times trailing earnings (versus an industry average of eight) and 10 times estimated earnings for the 12 months ending June 2017 (nine). Despite worries over the Virgin America deal, the stock's modest premium to peers appears justified, considering its lack of exposure to economic troubles brewing in Europe and Zika fears in Latin America. About 93% of its capacity was confined to the U.S. last year, with Mexico and Canada accounting for the remaining 7%. Alaska Air is a Buy and a Long-Term Buy.


Falling food prices have curbed Kroger's ($33; KR) sales growth and weighed on its shares, down 21% in 2016. U.S. prices for food purchased at grocery stores have slipped in eight straight months, including a 1.6% decrease in July, the sharpest decline since January 2010. Food prices may be bottoming out, given that no deflationary period has lasted longer than nine months since 1960, according to analysts at Goldman Sachs ($165; GS). Kroger has countered pricing softness with higher volumes from rising store traffic and market-share gains. Plus, gross profit margin stands at its highest level since the July 2009 quarter.

The stock looks attractively valued. At 15 times trailing earnings, Kroger shares trade 11% below their three-year median and 29% below the median for S&P 1500 food retailers. The stock trades at 14.5 times estimated year-ahead earnings, well below its peer-group median of 18. The consensus expects Kroger to grow per-share profits 6% in the 12 months ending April — nearly twice the industry norm. Kroger has topped the consensus in 10 consecutive quarters. Kroger is a Buy and a Long-Term Buy.


Lam Research's ($93; LRCX) near-term growth prospects lag its industry group, mostly comprised of far smaller semiconductor-equipment companies. The consensus expects Lam's earnings per share to climb 10% in the 12 months ending June, versus its industry's median growth of 15%. But analyst profit estimates for Lam have risen more sharply than those of its peers over the past 90 days. The stock also trades at just 13 times estimated year-ahead profits, a 21% discount to its industry median.

Lam has warned that its pending $10.6 billion acquisition of KLA-Tencor ($67; KLAC) may be delayed due to regulatory scrutiny. Management had originally expected to complete the deal, first announced in October 2015, by this Oct. 20. Some analysts now doubt the deal will be approved. However, rival Applied Materials' ($30; AMAT) blockbuster July-quarter results suggest the outlook for semiconductor-equipment spending is improving, potentially supporting Lam's growth even if the deal falls through. Lam is a Focus List Buy and a Long-Term Buy.


Lear ($116; LEA) shares have advanced 22% in the past 12 months, ahead of the S&P 500's 16% gain. But they have slumped 6% so far in 2016 on concerns about slowing automobile sales. Encouragingly, Lear reiterated in August its previous stance that U.S. auto sales have yet to peak, citing higher household incomes and population growth. Shares trade at nine times trailing earnings and estimated 2016 earnings, ranking among the cheapest 10% of stocks in our research universe on both metrics.

Sales growth has been consistent but anemic, rising in 16 straight quarters but not exceeding 4% since the three months ended December 2014. Currency headwinds deserve much of the blame for the slowing growth. However, operating profit margins have climbed in 10 straight quarters, and Lear sees opportunities for further expansion. Lear, yielding 1.0%, is a Focus List Buy and a Long-Term Buy.


Southwest Airlines ($37; LUV) shares slipped in August after the company tempered its September-quarter guidance, citing a July systems outage that delayed or canceled thousands of flights. Per-share profits are still projected to rise 9% in 2016 and 3% in 2017, with sales up 4% both years.

The fourth-largest U.S. airline by traffic, Southwest has historically traded at a significant premium to peers. It trailing P/E ratio has averaged a 27% premium to the average S&P 1500 airline stock in the past decade. At nine times trailing earnings, Southwest shares currently trade just 16% above their industry-group average. Also encouraging, the stock trades at nine times estimated 2017 earnings, roughly in line with the industry average. Southwest is a Focus List Buy and a Long-Term Buy.

PICK YOUR SPOTS AMONG VALUE STOCKS
The statistics below cover 532 companies in the Dow Jones U.S. Index categorized as value stocks and slotted into 24 industries. The Forecasts favors stocks from technology hardware, health-care equipment, and drugs. Auto parts, consumer services, and diversified financials boast notable Quadrix scores, while groups with the most stocks trading below historical norms on price/earnings ratios include banks and real estate. Based on estimated profit growth, attractive industries include consumer services, drugs, and staples retailing.
-------- Average P/E Ratio --------
Median Est.
-- EPS Change --
--- Number With ---
Industry (Number Of Companies)
A-Rated Value
Stocks In Group
Avg.
Div.
Yield
(%)
Curr.
Start
Of 2016
5-Year
Norm
No. Of
Stocks
Below
Norm
Curr.
Year
(%)
Next
Year
(%)
Avg.
Quadrix
Overall
Score
Overall
Scores
Above 80
Overall
Scores
Above 90
Auto Parts &
Components (8)
F, GM
1.9
9.9
11.5
10.6
7
15.1
3.5
84
6
2
Consumer Services (10)
none
2.2
17.2
23.3
21.3
6
10.8
10.4
74
2
0
Diversified Financials (17)
none
2.1
14.2
13.8
14.8
5
3.5
9.8
74
4
1
Insurance (43)
AFL, TRV
2.3
14.1
13.3
11.4
11
(2.4)
8.4
70
17
5
Retailing (16)
FL
3.5
15.6
15.2
15.0
9
(1.7)
8.0
70
5
1
Banks (49)
JPM
2.6
15.4
14.8
14.6
21
3.1
8.2
69
16
10
Telecom Services (6)
T, VZ
4.5
16.3
18.4
21.0
3
(4.5)
4.4
66
0
0
Drugs & Biotechnology (8)
AMGN,
ABBV, PFE
2.6
19.5
19.7
17.3
0
9.4
9.4
65
2
2
Technology Hardware (24)
CDW, CSCO
1.6
15.1
13.2
12.0
4
1.4
9.3
65
7
2
Cons. Durables &
Apparel (9)
DHI
2.6
20.3
18.2
15.8
3
9.7
11.7
64
2
2
Health Care
Equipment (14)
UNH
1.8
21.9
18.7
16.1
4
7.4
10.7
61
4
0
Media (15)
none
2.6
16.4
18.0
16.0
4
6.9
10.2
60
1
0
Semiconductors &
Equip. (17)
NVDA,
AMAT, INTC
2.0
23.8
22.5
20.7
4
8.4
12.5
59
4
0
Commercial Services (9)
none
2.5
19.8
13.2
18.5
3
3.8
11.3
58
1
0
Software & Services (19)
none
1.9
23.8
21.5
17.5
4
8.8
8.6
57
5
1
Transportation (3)
none
2.5
16.5
15.1
14.8
1
1.2
10.0
56
0
0
Capital Goods (35)
OC
1.9
18.1
14.9
15.0
9
1.8
6.8
55
4
2
Materials (32)
none
2.2
19.2
16.8
16.1
5
5.9
11.4
54
4
1
Food & Staples
Retailing (3)
none
1.8
27.6
22.2
20.5
0
16.2
12.0
48
0
0
Food, Beverage &
Tobacco (22)
none
2.6
23.0
21.9
18.5
3
9.1
9.1
48
2
0
Real Estate (81)
none
4.7
25.7
25.6
25.5
21
3.5
7.1
46
7
2
Utilities (54)
UGI
3.2
20.6
17.4
17.2
4
3.3
5.6
46
0
0
Household & Personal
Products. (6)
none
2.1
23.2
21.8
18.9
0
5.5
8.5
30
0
0
Energy (32)
none
2.2
12.0
13.5
12.8
5
(55.0)
39.8
26
2
0
Note: Quadrix scores are percentile ranks, with 100 the best.

 


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