By JACK HOUGH
Shares of the largest two-dozen American firms sell for 20% less than those of other companies based on forecast earnings. Giants are priced like dogs, in other words. History says buy them; the stocks investors like least ("value" stocks) tend to outperform the ones they like most ("glamour" stocks) over long time periods. But little about these companies suggests a turnaround is afoot.
It might not matter. New research suggests value stocks outperform, not necessarily because the companies they're attached to improve, but because investors judge them too harshly to begin with, and later soften their criticism. That means today's investors can seek refuge in discounted companies with plump dividends, strong cash flow, global sales exposure and stable profits, and likely secure bigger price gains than they would chasing after market darlings. Some picks in a moment.
Some academics cling tightly to the belief that risk and returns are inseparable--that the only way to secure higher returns is to invest less safely. In seeking to explain the outperformance of value stocks, then, people in this camp say that modest valuations must be a sign of risk. Why else would companies trade cheaply, if not for their added likelihood of failure? There are problems with this view, however. For example, cheap companies don't show other signs associated with riskiness, like volatile share prices.
Nick Magnuson, an analyst at The Brandes Institute, an investment research group, offers a different explanation in the latest edition of Journal of Behavioral Finance. Investors, rather than companies, account for the value premium. Magnuson looked at performance data for the largest half of rich-country companies between 1990 and 2009. In an average year, the most expensive decile of stocks by forward price-to-earnings ratios went on to lose nearly 1% in value over the following year. The cheapest decile gained nearly 12%. That is, value outperformed glamour by a whopping 13 percentage points a year.
When Magnuson looked at earnings surprises, the results were, well, surprising. Glamour stocks gained after beating Wall Street's earnings forecasts but got clobbered after missing them. Value stocks rose even more than glamour stocks following beats -- and even rose following misses. Other performance measures like margins and sales growth showed similar trends. Value stocks did great when margins were expanding and good even when they were deteriorating, whereas glamour stocks did just OK and lousy, respectively, under the same circumstances. Value stocks shined whether sales were rising or falling, and glamour stocks, in neither case.
Magnuson reckons this means that the average value stock is merely in the first part of an investor cycle--overreaction to setbacks. Later parts of the cycle include a gradual shift in sentiment and expansion of price-to-earnings ratios.
It's possible, of course, that the 20 years studied were particularly lousy ones for glamour stocks. The period included the dotcom stock bubble, after all. Then again, newly public LinkedIn (LNKD),
Below are listed six giant companies that sell for a song based on earnings and that offer meaty dividend yields. All of them look properly unattractive. Exxon Mobil (XOM)
Unless, that is, investor fears are overblown. If that's the case, holders of these stocks will collect an average yield of 3.3%, and enjoy handsome gains once the public decides these companies aren't such dogs after all.
|Exxon Mobil (XOM)||403,397||9||2.3|
|General Electric (GE)||194,928||13||3.3|
|Wal-Mart Stores (WMT)||187,310||12||2.7|
|Johnson & Johnson (JNJ)||183,739||14||3.4|
Data as of July 12, 2011