Value Stocks after the Rally | Lord Abbett
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Market View

We think there is one approach to identifying attractive U.S. value stocks that is well suited to the current environment.

Read time: 2 minutes

The economic dislocation caused by the onset of the COVID-19 pandemic was bad news for U.S. value stocks, traditionally an area of the market that is sensitive to cyclical shifts in the U.S. economy. For example, three classic cyclical industries within the S&P 500® Index—energy, airlines, and banks—were down 50%, 45% and 32%, respectively from the start of 2020 through November 6, based on Bloomberg data.

But the news of the efficacy of the Pfizer/BioNTech vaccine on November 9 last year changed things dramatically. From that date through June 17, the three cyclical groups have returned 91%, 50% and 59% respectively. As the U.S. economy has reopened and grown rapidly since the wide rollout of the COVID-19 vaccines and the implementation of massive government stimulus, value companies have benefited significantly, with the Russell 2000® Value Index rising 56% since November 9.

And while some market observers have opined that the strong run in value stocks may be nearing its end, we think such pronouncements may be premature. While it is impossible to predict the future, we believe fundamentals suggest that value may have more room to run. One reason, as seen in Figure 1, is that even after the explosive rally, value’s forward price-to-earnings (P/E) ratio remains very close to its long-run average—a noteworthy development considering the explosive growth in earnings among value companies (Figure 2) and the fact that the market multiple as whole has expanded.

 

Figure 1. Despite the Recent Rally, Value’s P/E Remains Near the Long-Term Average
One-year forward price-to-earnings ratio (monthly) of the Russell 2000® Value Index, January 31, 2001–May 31, 2021

Source: BNY Mellon. Monthly data as of May 31, 2021.
Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

Figure 2. Value Earnings Have Surged in 2021 after a Pandemic-Challenged 2020
Earnings per share (EPS) growth for the Russell 2000® Value Index for the indicated periods

Source: Russell, Refinitiv, FactSet, and Credit Suisse. Data as of DATE. E=Estimated.
Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

We think another reason to consider these cyclically sensitive equities is the strong prospects for a U.S. economy that has been lifted by massive government stimulus and widespread administration of COVID-19 vaccines. Consensus forecasts calling for high year-over-year U.S. gross domestic product (GDP) growth for the rest of 2021 (9.0% for the second quarter and 6.6% for the full year, according to Bloomberg data), could provide an additional tailwind to value stocks, in our view.

How might investors best approach the ongoing opportunity in value? As we opined in the March 1, 2021, Market View, they “may need to move away from rigidly defining value based solely on [price-to-book value] and instead focus on metrics that reveal operating strength and/or improvement, operational agility, and market durability.” We think one important criterion for identifying attractive value stocks is to focus on companies with high normalized free cash flow yields. In our view, this approach positions asset managers to find companies that have currently depressed valuations but are likely to have robust mid-cycle free cash flow.

We believe the concept of durability in cash flows, as well as flexibility in thinking beyond traditional valuation metrics, is critical in identifying investment candidates in an environment marked by widespread innovation-related disruption.

Lord Abbett Product Consultant Shannon Ahern contributed to this article.

 

A Note about Risk: The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. While growth stocks are subject to the daily ups and downs of the stock market, their long-term potential as well as their volatility can be substantial. Value investing involves the risk that the market may not recognize that securities are undervalued, and they may not appreciate as anticipated. Smaller companies tend to be more volatile and less liquid than larger companies. Small cap companies may also have more limited product lines, markets, or financial resources and typically experience a higher risk of failure than large cap companies. The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall.

No investing strategy can overcome all market volatility or guarantee future results. 

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This Market View may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize, or that actual returns or results will not be materially different from those described here.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future.

Glossary and Index Definitions

 

Earnings per share (EPS) is a company’s earnings divided by the number of shares outstanding. EPS can also be computed for an index such as the S&P 500.

Free cash flow yield is a ratio that compares the free cash flow per share a company is expected to earn against its market value per share. The ratio is calculated by taking the free cash flow per share divided by the current share price. Free cash flow represents the cash available for the company to repay creditors or pay dividends and interest to investors.

Growth/Value Investing: Growth stocks may be characterized as equities of companies that have demonstrated better-than-average gains in earnings in recent years and that are expected to continue delivering high levels of profit growth. Growth equities typically carry higher price-to-earnings multiples than the broader market, high earnings growth records, and greater volatility than broader market. Value stocks may be characterized as equities of companies that have fallen out of favor with investors but still have good fundamentals, or new companies that have yet to be recognized by investors. Value stocks typically feature lower price-to-earnings multiples than the broader market, and, often industry peers; and somewhat lower volatility than the overall equity market.

The Price-to-Book ratio compares a company's market value to its book value. The market value of a company is its share price multiplied by the number of outstanding shares. The book value is the net assets of a company.

Price-to-Earnings Ratio: Stock analysts calculate a price-to-earnings ratio by dividing a stock's current price by its earnings per share on a trailing 12-month basis. A forward price-to-earnings ratio is calculated by dividing a stock's current price by estimated future earnings per share.

The Russell 1000® Index measures the performance of the 1,000 largest companies in the Russell 3000 Index, which represents approximately 92% of the total market capitalization of the Russell 3000 Index.

The Russell 1000® Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.

The Russell 1000® Value Index measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values.

The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.

The Russell 2000® Growth Index measures the performance of those Russell 2000 companies with higher price-to-book ratios and higher forecasted growth values.

The Russell 2000® Value Index measures the performance of those Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values.

The S&P 500® Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in this Market View are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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