A New Look for Value Stocks


By Pearl Wang From Standard & Poor's MarketScope

As value investing appears ready to come back into vogue, some investors are redefining the term.

Large-cap stocks such as Home Depot (HD

; S&P investment rank, 5 STARS; recent price, $42), Microsoft (MSFT

; 5 STARS; $28), Pfizer (PFE

; 3 STARS, hold; $21), and Wal-Mart (WMT

; 5 STARS; $50) have historically been thought of as growth stocks, not value plays. These companies are well-known blue chips with what Standard & Poor's sees as strong fundamentals, and their share prices haven't been beaten down.

INFLATION PROOFING? However, at the Nov. 15-16 Value Investing Congress, held in New York City and attended by more than 400 investors, one major theme was the appeal of large-cap blue-chip stocks. Increasingly, investors appear to be starting to define these as "value" stocks.

It's a theme Standard & Poor's supports. "In the typical investment cycle, large-cap value stocks typically come into vogue as the economic recovery slows and fears about inflation begin to pick up," says Sam Stovall, S&P's chief investment strategist.

Stovall notes that value stocks, which also tend to have larger market caps, get more investor attention for four primary reasons, in S&P's view: their earnings stability and transparency; their increased likelihood to have long-term contracts with their customers and pricing flexibility; a broad diversity of product or service offerings; and their well-established track records.

"HIDING IN PLAIN SIGHT." At the Value Investing Congress, speaker Joel Greenblatt, author of Magic Formula Investing and founder of Gotham Capital, elaborated on what he believes to be the key to investment success: invest in good companies that have high returns on capital and whose stocks are cheap. He defines cheap as those stocks that have high earnings yields (a company's pretax operating earnings compared with its enterprise value, which is its market value plus net debt). "Some of the cheapest things I'm seeing are very large market caps," he said.

Another conference speaker, Mark Sellers of Sellers Capital, believes bargains are "hiding in plain sight" among the large caps. He believes that high-quality large-cap growth stocks are a good bet over the next few years. Sellers sees mutual fund investors pulling money out of the large-cap group as a potential contrary indicator.

Standard & Poor's equity strategist Alec Young agrees: "Smaller companies have outperformed over the last few years, and the larger-caps have underperformed. We're looking for that to shift as this bull market and the economic cycle age." Among Sellers' favorite stocks these days: Home Depot, Wal-Mart, Microsoft, and Pfizer.

REDMOND'S APPEAL. S&P equity analyst Michael Souers believes that Home Depot's powerful cost-saving synergies from expansion into the $410 billion professional market will remain one of the company's primary growth engines. Plus, the rebuilding efforts from the devastating hurricane season should boost sales and earnings for many years to come, in his opinion, offsetting a potential housing-market slowdown.

Microsoft is a top pick of S&P Computer Software equity analyst Jonathan Rudy. "With more than $40 billion in cash and short-term investments, and notably higher earnings quality than peers, in our view, we would buy [the stock], with shares trading at discount to peers on P/E and p-e-to-growth," Rudy writes. Microsoft is a pick of another speaker at the Value Investing conference, Rich Pzena, head of Pzena Investment Management, who disclosed that he has been adding it to his firm's portfolios over the past six months.

The value appeal of the stocks mentioned above is heightened by other factors. Currently, each is a member of Standard & Poor's Platinum Portfolio, which includes the stocks that carry top rankings under S&P's Fair Value quantitative ranking system and its Stock Appreciation Ranking System (STARS), a qualitative stock-selection methodology.

BARGAIN BIN. The top Fair Value rankings are noteworthy, as they indicate that the stocks are considered undervalued under S&P's system, which calculates a stock's weekly Fair Value -- the price at which a stock should trade at current market levels -- based on fundamental data such as corporate earnings and growth potential, price-to-book value, return on equity, and current yield relative to the S&P 500-stock index.

The growing buzz about high quality large-cap names may signal that for value investors, these days, big is beautiful.

Wang is a reporter for Standard & Poor's Global Editorial Operations


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