Lots to Choose from, but Choose Carefully
While the profitability and valuation spreads may be flashing green for value, investors must be selective. After all, stocks can be cheap for good reasons that can lead to bad outcomes. So equal attention should be paid to business fundamentals, as high-quality companies with strong earnings potential tend to be rewarded over time as they attract more investors.
Of course, some value stocks are cyclically exposed and will fall in and out of favor as economic conditions shift. However, with broader market returns driven by such a narrow set of mega-cap growth companies, value opportunities have widened to include many choices that are less sensitive to macroeconomic moves. Indeed, we’ve found that the value universe is now flush with quality companies of all sizes and in all industries and sectors, many with solid earnings trajectories underpinned by company-specific drivers, niche-industry trends and structural changes in the US economy.
Quality as a Value Driver
Many attractively valued stocks with strong balance sheets and robust profitability have fallen from favor. But firms with improving business quality to support earnings growth offer compelling recovery potential, in our view.
Value Can Tap Dramatic Economic Changes
Some value companies enjoy a supportive industry structure. Trends such as supply chain protection and reshoring, energy transition and cybersecurity are gathering pace. Select firms have attractively valued shares that don’t reflect their potential to access these themes, in our view. Companies that facilitate efforts to bring US supply chains closer to home should benefit from the reshoring wave.
No More Compromising Quality…or Excitement
In his seminal book on behavioral economics, the late Daniel Kahneman quipped that it’s easier to strive for perfection when you’re never bored. We think this observation applies to value investing now more than ever. This isn’t a typical value downcycle. Nor is this your grandfather’s value pond—traditionally stocked with lower-quality companies that forced investors to make tough compromises in the quest for good value.
More value companies today are thriving and stack up strong against their growth peers in terms of end-market dominance, competitive positions and profitability. Investors who crack the quality code by identifying companies with improving fundamentals can capture attractive recovery potential from value stocks, as their changing characteristics are gradually unlocked by the market.
The authors would like to thank Snezhana Otto, Senior Research Analyst—Value Equities at AB, and Dennis Stakhov—Senior Quantitative Research Analyst—US Value Equities, for their research contributions to this blog.
