Published November 2001

‘Value’ stocks aren’t flashy but are worth having

During the long bull market of the 1990s, many growth stocks soared to unheard-of heights and, in the process, captured the public’s imagination. As a result, a lot of people paid far less attention to “value” stocks.

But in 2000, when the bubble burst for a lot of high-flying growth stocks, many value stocks did quite well — which came as no surprise to savvy investors.

Over the years, value investments have outperformed growth investments many times. But smart investors don’t buy value stocks because they anticipate superior short-term performance. They like the other benefits that value stocks can give them: reasonable prices, lower volatility and greater predictability.

What, exactly, is a “value” stock? Here are a few characteristics to look for:

• Long history of earnings. You might think that profits are a basic prerequisite for any investor considering a stock. But many new technology companies, particularly the dot-coms, had no earnings — even while their stock prices were taking off. By contrast, value stocks typically have long track records of profitability. And the best value stocks have several years of continuously improving earnings.
• Low price for each dollar of earnings. When you invest in a stock, you’re hoping that it earns money — if not today, then tomorrow and for a long time to come. You’re willing to pay a certain price for each dollar of earnings. If you’re investing in an aggressive growth stock, you’ll probably pay a high price; in other words, you’ll be investing in stocks with high price-to-earnings (P/E) ratios. A P/E ratio of 50 or more is generally considered to be a “red flag” that a stock may be overpriced. For example, some dot-coms at their peak had P/Es of 80 or higher! But a value stock, by definition, has a relatively low P/E — possibly 15 or less.
• Lower volatility. Like all stocks, value stocks will fluctuate in price. But they generally don’t move up and down as much, or as fast, as growth stocks. If you’re statistically minded, you can compare the “beta coefficients” of value stocks with those of growth stocks. A beta coefficient is a measure of a stock’s relative volatility. The S&P 500 Index, which is widely viewed as an indicator of the market’s performance as a whole, has a beta coefficient of 1. Stocks with a beta greater than 1 are considered more volatile than the market as a whole. Conversely, stocks with a beta less than 1 are less volatile and will rise and fall more slowly than the market.

In short, if you like favorable valuations but not a lot of surprises, you may be interested in value stocks. At the same time, don’t forget the benefits of diversification. Your portfolio doesn’t have to be strictly “value” or solely “growth” — it can easily contain both (and probably should). In the end, you’ll find that owning both types of stocks will give you more opportunities for success. And when it comes to investing, that’s real value.

Eric Cumley is an Investment Representative with Edward Jones Investments at 1201-C SE Everett Mall Way in Everett. He can be reached at 425-353-2322. Edward Jones is an NYSE-member investment firm with more than 7,000 locations nationwide.

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