What Are Value Stocks? Why Are They Suddenly Important?

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Guide to Value Investing in the Stock Market: P/E Ratios and More

Value stocks are surging in 2021 as the market positions for the economy to rebound. It’s a big change from recent years, when so-called growth stocks like Apple and Facebook dominated.

Retail investors with less experience may be struggling to adjust because they’re familiar with the prominent technology companies. However the market often passes through multiyear cycles. Understanding changes in investor sentiment can help traders avoid areas of weakness and focus on new opportunities.

This article will help by explaining:

  • Value stocks vs growth stocks
  • How to find value stocks
  • Why higher rates favor value stocks
  • Value stocks to know about now
  • Value stock ETFs

Value Stocks vs. Growth Stocks

Value stocks are typically companies that trade at inexpensive multiples compared with metrics like earnings, book value and dividends.

Value stocks usually trade at a discount to their expected earnings power over a longer time frame. It was first clearly defined by Benjamin Graham and made famous by Warren Buffett at Berkshire Hathaway (BRK.B). Charlie Munger, Bill Miller and Mario Gabelli are other famous value investors. Value stocks are typically members of established industries.

Growth stocks, on the other hand, are growing faster than most other companies in the market. They often have innovative products or are “disruptors.” Recent examples include Zoom Video Communications (ZM) or Snap (SNAP). Because their products are so unique, they often trade at premiums to their earnings power.

Classic growth stock Zoom Video Communications (ZM), daily chart, with 50-day moving average and key events.

How to Find Value Stocks

Value investors can potentially discover value stocks by screening on these key metrics:

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  • Price to earnings ratio (P/E): Per-share earnings divided by share price. Lower readings indicate “cheapness.” However it’s important to remember that “normal” P/E ratios vary widely by industry. It can be most useful to compare stocks to their peers.
  • Price to book ratio (P/B): Book value, or equity, is a company’s assets minus its liabilities. Lower readings suggest a company may be undervalued. P/B can be useful for industrial stocks and financials. It’s less important for technology stocks, whose balance sheets may understate the true value of their assets.
  • Dividend yield: This expresses a company’s annual dividend as a percentage of its price. Higher yields suggest a stock is “cheap” relative to its cash payouts.

Why Higher Rates Favor Value Stocks

Interest rates have soared recently as investors look for the economy to reopen from the coronavirus pandemic. This favors value stocks over growth stocks for two reasons.

First, value stocks like energy and financials tend to be “cyclical.” That means they benefit from faster economic growth, which forecasters now expect. A stronger economy also investors less willing to pay a premium for innovative companies.

Second, higher interest rates favor value stocks because of “earnings yield.” This is the opposite of P/E ratio. Instead of dividing price by earnings, you divide earnings by price.

A company with a $20 share price and $1 per share of earnings will have a P/E ratio of 20. Its earnings yield will be 1 / 20, or 5 percent. Higher P/E ratios result in lower earnings yields.

Investors often compare earnings yields to the 10-year Treasury Yield. Higher Treasury yields, like we’ve seen recently, can make investors favor stocks with higher earnings yields. Likewise, companies with low earnings yields (high P/E ratios) can get punished.

Value Stocks to Know

Based on the screening methods cited above, here are some major value stocks to know about now.

  • Wells Fargo (WFC): The bank still trades for less than book value despite rallying 23 percent this year. It’s also trying to turn its business around after the 2016 fraudulent-account scandal.
  • Citi (C): The sprawling multinational bank trades for 0.8 times book and about 10 times earnings. Its 3 percent dividend yield is almost twice the yield of the 10-year Treasury note.
  • Unum Group (UNM): The insurance company trades for less than 7 times earnings and about half its book value.
  • General Motors (GM): The automaker trades for 8 times earnings. It’s also in the process of introducing electric vehicles, which could potentially increase its multiples.
Wells Fargo (WFC), daily chart, with 50-day moving average.

Value Stock ETFs

Investors seeking value stocks may also want to consider exchange-traded funds (ETFs) dedicated to this approach. ETFs are buckets of stocks tracking certain themes or indexes. They can offer more diversification and less risk, but with the convenience of a single security. Here are some major value-stock ETFs:

  • Vanguard Value ETF (VTV) is one of the largest ETFs holding value stocks, with about $68 billion of assets.
  • iShares Russell 1000 Value ETF (IWD) is another large value-stock ETF. It has about $47 billion of assets.
  • iShares MSCI EAFE Value ETF (EFV) is a major value-stock ETF that focuses on international companies like Novartis and Toyota Motor. It has about $12 billion of assets.
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