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Portfolio Strategy

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Where have all the bargains gone?

Investors have picked them every one.

Pete Seeger had his eye on bigger themes than the stock market when he wrote Where Have All the Flowers Gone , but what a great summary of the investor's plight today. The stock markets are way up, and the opportunities to buy low-priced stocks are few.

So how about calling in the bargain-hunting experts to help? They're called value investors and they use an approach to stock picking that was developed by Benjamin Graham in the 1930s and later popularized by Warren Buffett, and that is now available to retail investors through a variety of mutual funds and exchange-traded funds.

Value investing means buying cheaply priced stocks and then waiting for everyone else to follow along. Among those who feel this is the right approach today is Eric Kirzner, who holds the John H. Watson Chair in Value Investing at the University of Toronto's Rotman School of Management.

"The markets have had a huge bounce, bigger than anybody would have anticipated, and many stocks have moved close to their precrash levels," Prof. Kirzner said. "This is now a stock picker's market."

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While there are numerous splinter groups and subsets, the business of picking stocks breaks into two camps. There's value and there's growth, which keys on companies with fast-growing revenues and profits. Growth had its moments in the last phase of the bull market that died in 2008, but value's been the much better performer since then. Should investors stick with it?

"Absolutely," Prof. Kirzner said. "The value approach would be the one to use right now."

Not all value adherents are that enthusiastic. Francis Chou, one of Canada's most respected value investors, recently warned clients in his 2009 annual report that he's having trouble finding bargain-priced stocks to buy, and that stock market risk has risen over the past year.

But other value managers say they continue to find stocks to add their portfolios. "Clearly, it's not as attractive as it was out there," said Jeffrey Stacey, partner at Stacey Muirhead Capital Management in Waterloo, Ont. "But I do not think prices are excessive yet."

Within the value camp, there are so-called deep value managers who will on occasion buy into companies of lesser quality provided they're available on the cheap, and others like Mr. Stacey who seek quality companies at bargain prices.

"We try to buy as cheaply as we can," he said. "But, as the Buffett quote goes, we'd rather pay a fair price for a wonderful business than a wonderful price for a fair business."

More about Warren Buffett:

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Mr. Stacey said the stocks his firm owns include Nike, Indigo Books & Music and Fairfax Financial, a financial holding company that is itself run by a respected value investor, Prem Watsa.

Indigo remains a value stock in Mr. Stacey's eyes, even though it has risen to about $18 from just under $11 a year ago. He said the company has a clean balance sheet, growing sales, roughly $5 a share in excess cash and, based on expected earnings, it has a price/earnings ratio of about 10.

Prof. Kirzner's take on value stocks focuses mainly on such mainstream, bricks-and-mortar names as Coca-Cola, General Electric and BCE. "You're really buying the economy," he said.

Value investors use different methods of finding low-priced stocks, but the most basic measure is a low price/earnings ratio, which shows how expensive a stock is in comparison to its earnings per share. Value investors go for low P/E stocks, growth investors for high P/E stocks. One expert said the threshold for value is a PE under 15.

Prof. Kirzner said that over the long term, value stocks - that would be low P/E stocks - have outperformed higher P/E growth stocks by three percentage points. Every so often, however, growth investing does take the lead.

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