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.
Stocks of high-growth companies can help investors beat the market but there are some downsides. Often the fast-growth trajectory is already reflected in the price of the stock, making it difficult to distinguish between the real opportunities and the overpriced.
And then there are the growth stocks that have morphed into value plays.
People tend to look at value and growth strategies as opposites. But they are not as mutually exclusive as that. In some ways, they are phases on the same spectrum.
Growth companies generally reinvest in their business rather than return money to shareholders, but there comes a time when that changes. Onetime high-flying growth stocks like Apple now trade a lot more like value stocks, with low price-to-earnings ratios relative to other stocks in their sector and healthy dividend payouts.
At a multiple of around 17 times the past 12-months earnings, Apple shares trade more like a steadily growing bank, Citigroup, than an Amazon.com, the blazingly fast-growth internet retailing giant, especially compared to the average tech sector multiple above 20. It even trades below the S&P 500′s multiple, around 19.
Yet, interestingly, Apple is still represented in the growth index, not the value benchmark.
It is a top-10 holding of the Russell 3000 Growth index, alongside Microsoft, Amazon, Facebook, Google’s Alphabet, Visa, UnitedHealth, Home Depot and Boeing. This index has an average price-to-earnings north of 26 and five-year earnings per share growth of 13.8 per cent.
Meanwhile, the Russell 3000 Value Index holds J.P. Morgan, Berkshire Hathaway, Exxon Mobil, Bank of America, Johnson & Johnson, Intel, Wells Fargo, Chevron, Pfizer and Cisco. The group has an average price-to-earnings of about 17 and five-year EPS growth of 4 per cent.
Broadly speaking, rising markets tilt in favour of growth stocks, which means value stocks by their nature become defensive. That’s why utilities and consumer staples show up in greater numbers in value indexes and technology and consumer discretionary stocks tend to be over represented in growth indexes.
Apple’s continued representation as a growth stock may simply reflect the market’s current bias for the tech sector over all. It certainly is responsible for much of the gains over the past year.
As for Apple, Warren Buffett’s attention is another indicator that it has flipped to the value side of the spectrum. Since it began paying a dividend in 2012, the payout has steadily increased. Berkshire has amassed a large stake in the company since 2016, now its second-largest holder.
But an investment in Apple today isn’t going to result in the same spectacular growth that investors from a decade or more ago have seen. For the stock to double, Apple’s market value would have to be well above US$1-trillion. It is among the handful of companies that are in range of that psychological barrier, but growth will be more likely slow and steady. In other words, it’s the kind of stock that appeals to value investors like Mr. Buffett.
The fund manager John Neff guided Windsor Fund to a nearly 14-per-cent annual return from 1964 to 1995, outpacing the 10-per-cent return of the S&P over the same time, by focusing on low-multiple stocks of companies that were steadily growing. He called it a “dull” and “prosaic” approach, especially compared to Wall Street’s swashbuckling ways. But his approach showed that investors often overlooked opportunities because they were focused on higher-growth areas.
At Validea, we have a model built to find low-P/E stocks using Mr. Neff’s philosophy, which looked for sustainable EPS growth of 7 per cent to 20 per cent and positive free cash flow. Here are three stocks that score highly on that model.
PacWest Bancorp (PACW) – This bank focuses on providing lending and other services to small and mid-sized companies and startups. The stock has a P/E of 15 and average EPS growth of more than 18 per cent.
Pinnacle Financial Partners (PNFP) – This is a community bank in the U.S. Midwest. Adding its EPS growth rate and yield and dividing it by the P/E gets a total return of 1.14, more than double the market average total return of 0.49.
Taiwan Semiconductor (ADR) (TSM) – The company is the largest dedicated chip foundry. The stock has a P/E of 16.7 and an average EPS growth rate of 14.4 per cent.
John Reese