Table of Contents
The late 1990s were a much different time from now – popular sentiment then was at the time at the most optimistic point in modern history, while now we find ourselves at the most pessimistic juncture of our lifetime. One thing in common between these two times is investor faith in technology stocks (QQQ) translating into high valuations compared to value stocks.
The new millennium strongly favored old-school value investors for the first few years, as many high-momentum technology companies failed to live up to the hype. In the midst of this, a startup asset management firm founded by some ex-Goldman Sachs employees in 1998 combined the two by investing in value stocks and momentum at the same time. That firm was AQR, which today counts among the world’s largest asset managers. The idea was that value investing and investing in momentum are both strong strategies, they’re negatively correlated, they revert to the mean over the long term, and when you combine them, you can beat the market. The old idea of combining value investing with momentum may now be the best idea of 2020 as we move forward in an uncertain world.
Long-time readers of mine should be familiar with my S&P 500 return models, which I periodically update. One interesting thing about the models is that small changes in valuation (i.e., pullbacks) have little impact on long-run return estimates, giving support to the idea that long-term investing is a solid strategy for building wealth. However, my return estimates have fallen over the last 2 years as earnings have failed to keep pace with valuations. I reran my model (using 2019 SPY earnings as a baseline) and got an expected return of around 8.9 percent for the S&P 500 (SPY), which is a little below the historical average.
Oceans of ink have been spilled over various ways to earn more than the long-term expected return of the S&P 500, but two of the oldest ideas are the easiest for ordinary investors to implement. My most successful stock picks over my lifetime have tended to fit into one of these two categories. The first approach is to invest in technology, which has a growth rate higher than the nominal GDP growth rate. The second is the Graham-Dodd-Buffett style of value investing, which is to buy cash flow-producing companies for lower prices than the market as a whole. My consulting clients typically either start in one camp or the other, but after some quick math, they come around to main-line finance theory, which gives you a strong chance of beating the market with a minimal amount of complexity.
AQR’s research has shown that value and momentum, owned together and rebalanced periodically, perform better than either in isolation. When two assets have negative correlation and mean reversion over the long term, this allows you to collect a “rebalancing bonus,” which is an extra source of return. Unlike much academic research, these strategies are effective for long-only investors, which I know many of my readers are.
Without further ado, here are a few value stocks that I’ve been looking at.
- ~16 percent earnings yield.
- Liabilities mostly fixed, meaning could benefit from inflation/yield curve steepening.
- Taking steps to unlock value in the business by making strategic acquisitions and dispositions.
- Coronavirus’s impact on policyholder mortality shouldn’t be permanent.
- Multiple lines of insurance business diversify risk.
- 5 percent dividend yield.
- Oil arm of Gazprom, ~14 percent earnings yield.
- Not eligible for ETF inclusion due to the lack of float.
- Political risk due to coronavirus impacting Russia’s finances, priced in.
- Oil likely to rebound to $100 after the crisis due to suppliers being forced out of the market this year market may not be able to keep up when demand returns, especially given the long-term insatiable demand growth in China.
- 7 percent yield.
- Not highly liquid, but can trade $5,000-10,000 blocks easily.
- Large regional bank based in South Florida (with branches in New York also), hard hit by coronavirus lockdowns due to tourism’s decline.
- Trades for 7x 2019 earnings, 14.5 percent earnings yield.
- Too cheap for a historically well-run bank.
- Trump may approve additional stimulus for the tourism industry before the election, in my opinion (swing state), giving optionality and upside.
National Storage Affiliates Trust (NSA)
- Trades for 21x funds from operations, the most expensive stock on the list.
- Earns money on the large spread between self-storage cap rates and interest rates. This allows for continual growth, as the spread can be leveraged and releveraged.
- Opportunity for vertical integration as the company grows in size, margins should increase in lockstep.
- Optionality when self-storage properties are bought out to be redeveloped, large capital gains.
- I listen to the company’s conference calls quarterly, I like its management.
- The risk of oversupply should abate given credit tightening for marginal players.
- Liquidity is much better after 9 am Central.
- 11 percent earnings yield (and recently affirmed earnings guidance), dividend yield nearly 9 percent – with stable cash flow. Earnings growth over the long run likely in the 2-3 percent range.
- Paid a lot of goodwill for Juul, since charged off. Not your problem if you weren’t a shareholder back then.
- One of the best-performing stocks in the entire market since inception, even amidst constant litigation and changing environments. Perpetually cheap stock that pays a great dividend.
- People are smoking more since COVID-19 happened (go figure). Altria does have diversified lines of business, with alcohol, Juul, and cannabis profits growing.
I think it’s very reasonable to own the Nasdaq for the long run. In fact, there’s a strong argument that it should always be your largest holding. However, a portfolio of well-chosen value stocks will balance out tech in your portfolio. Unlike the traditional metrics of value and growth, well-thought out value and momentum strategies avoid two groups of stocks with low returns – popular stocks with high valuations and low earnings momentum that tread water, and junk/value traps, which are companies that lose money. Feel free to add comments on any of the above stocks, I’d like to know what my readers think of them.
Like what you’re reading? Follow me for future research updates!
Disclosure: I am/we are long MET, NSA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.