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With the U.S. stock market reaching all-time records, thoughts turn to next year, and whether the long-awaited shift to value stocks has arrived.

Value investors haven’t had much good news to keep them going in the past few years. Low interest rates and slow economic growth worked against the strategy. Growth-oriented stocks, particularly in the technology sector, have dominated the headlines.

But then it happened. There was a surge in value stocks starting in late August, stoking hope that the shift away from highly valued technology stocks toward undervalued companies was beginning.

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After all, many investors have been waiting for the torch to be passed from popular but more expensive growth stocks to cheaper stocks of companies that are linked to a strong U.S. economy.

Since late August through Dec. 18, the Vanguard Value ETF is up 12.8 per cent while the Vanguard Growth ETF is up 10 per cent. Not huge outperformance, but value is outdoing growth more recently.

Year to date, the value index is trailing the growth index by a wide margin, but the recent move in value could be the early signs of a longer-term trend in the markets.

This isn’t the first time over the past few years when value has started to perk up. In late 2016, after the U.S. presidential election, value went on a good run, but it was relatively short-lived.

Value and growth are typically seen as opposites. Value companies have mature businesses with steady but modest growth and sometimes strong pricing power. Growth stocks, on the other hand, are companies with growing sales and earnings in which the expectations for future growth in investors’ eyes remains strong.

In some cases, value and growth converge. Apple, for example, is a huge company with a solid brand. It’s no longer the pure-play growth stock it used to be. Even value-investing legend Warren Buffett has joined the party. His Berkshire Hathaway has become one of Apple’s biggest shareholders in the past couple of years, despite Mr. Buffett’s famous aversion for all things tech.

Mr. Buffett is also a huge fan of U.S. bank and financial companies, and that should give value investors some comfort. Despite the roaring upward climb in the growth-stock sector over the past few years, one of the most prominent value investors has been confirming his commitment to the value approach.

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Historically, value has typically beaten out growth. Investors overprice growth stocks and underprice value stocks. When the growth names disappoint, the overvaluation results in large losses. When the underlying business of the value-stock cohort revert, albeit by the smallest amount, these cheap stocks tend to generate excess returns. At least that is what is supposed to take place. But over the past few years, growth stocks have delivered on their fundamental expectations while value stocks (e.g. energy, financials, retailers) have continued to see challenging environments.

But over the very long term – over decades, not just a few years – the evidence points to having an allocation to value stocks. Sooner or later, value stocks will have their day in the sun again, and that day may have already started.

At Validea Capital, we run multiple strategies focused on value stock selection. The table below combines two of our value models in a combined screen. We looked for stocks that achieved high marks based on Jim O’Shaughnessy’s Value Composite, a quantitative model outlined in the book What Works On Wall Street that looks at multiple value metrics and combines them into one composite score, and the model based on Joel Greenblatt’s Magic Formula from his book The Little Book That Beats the Market, which looks at valuation and return on capital and ranks stocks based on the combination of those two factors.

A shift back to value stocks?

NameTickerUS$ PriceMkt Cap (US$-Mil)P/E RatioP/S RatioP/B RatioP/CF RatioDiv. Yield
Acco Brands CorporationACCO-N$9.68 $939 9.70.51.25.42.7%
Donnelley Financial Solutions IncDFIN-N$11.17 $383 12.90.41.44.8 n/a
Hewlett Packard Enterprise CoHPE-N$15.91 $20,570 14.20.71.25.13.0%
Lear CorporationLEA-N$140.68 $8,507 10.50.4262.1%
Wabash National CorporationWNC-N$15.73 $851 10.60.41.76.92.0%
Meritor IncMTOR-N$24.43 $1,909 7.30.45.25 n/a
Oshkosh CorpOSK-N$92.87 $6,320 11.20.82.491.3%
Walgreens Boots Alliance IncWBA-Q$57.20 $50,793 13.30.42.28.53.2%

Source: Validea 

John Reese is chief executive officer of Validea.com and Validea Capital, the manager of an actively managed ETF. Globe Investor has a distribution agreement with Validea.ca, a premium Canadian stock screen service.

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