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 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.
Value investors can potentially discover value stocks by screening on these key metrics:
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.
Based on the screening methods cited above, here are some major value stocks to know about now.
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:
This article was written by David Russell, TradeStation Securities, Inc., part of the Monex Group Inc, published on 05/03/2021.
David Russell is VP of Market Intelligence at TradeStation Group. Drawing on nearly two decades of experience as a financial journalist and analyst, his background includes equities, emerging markets, fixed-income and derivatives. He previously worked at Bloomberg News, CNBC and E*TRADE Financial. Russell systematically reviews countless global financial headlines and indicators in search of broad tradable trends that present opportunities repeatedly over time. Customers can expect him to keep them appraised of sector leadership, relative strength and the big stories – especially those overlooked by other commentators. He’s also a big fan of generating leverage with options to limit capital at risk.
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