Bloodied, bruised and practically given up for dead through much of the late 1990s, value investors finally got up off the mat in 2000. For the first time in years, the conservative ways of value investing won out over the riskier and brasher growth-investing sector across a spectrum of market indexes.
It was the first year since 1993, for instance, that the S&P/Barra 500 Value Index beat the S&P/Barra 500 Growth Index. In the small-cap market, the gap was astonishing: The Russell 2000 Value Index closed the year up 22.83% compared with a loss of 22.43% for the Russell 2000 Growth Index.
Not bad, considering the first two months of 2000 were as dark as any time during the 1990s for value investors. Anthony M. Maramarco, manager of the Babson Value Fund, remembers those months well. Value had been "whacked'' in 1999, after having been beaten up by growth in 1998. Then, the Nasdaq started the new year with a flourish, and at the end of last February, net assets in value funds were down 18%.
"It was a bloody mess," Maramarco recalls. "I tell people here I was glad I didn't have windows I could open in February because it was bleak."
But even Maramarco isn't ready to uncork a bottle of champagne just yet. It's a flighty market nowadays, and few are willing to declare that investors have cast growth aside and made a full commitment to value. The rise of value coincided with the collapse of the Nasdaq market and the fall of the dotcoms starting in March.
It isn't that value's performance in 2000 was terrific, because it wasn't. In other years, the 7.01% gain of the Russell 1000 Value Index could be considered mediocre. But in a year when the Russell 1000 Growth Index fell 22.42%, the value results were something to celebrate.
Value stocks just look a lot better when compared with the miserable performance of growth. "I'm not sure this is a great value market yet," said Timothy P. Vick, senior analyst at Arbor Capital Management in Ann Arbor, Mich., and editor of the stock market newsletter Today's Value Investor. "All it is is people fleeing techs and trying to find something else to put their money into."
As the information economy exploded in the late '90s, many older companies found themselves confronted with what Wall Street began to call the "classic value trap." Take a giant insurer like Allstate, with a strong balance sheet, well-known brand name but cyclical earnings. Its stock was dirt cheap, but its market was changing and growth was slowing, raising questions about its future.
One can also argue that value's recovery was partly due to happenstance. A rise in oil prices, stabilization of interest rates and a flight from New Economy stocks all played into the hands of value investors, giving a boost to their favored industries. Expected increases in federal reimbursements to hospitals helped the health-care sector. Energy, utilities, real estate and financials-all staples of the typical value investor's portfolio-also had standout years. "It's not a growth-versus-value type of issue," says Edward B. Baldini, co-manager of the MFS Value Fund. "It's not that 'value' has gone up. The sectors that value gravitates to have gone up."
Yet even with the long-term picture still unclear, value investors have reason to be hopeful. Just one year ago, value was viewed by some on Wall Street as archaic and out of sync with New Economy companies. Simple value was no longer good enough. There was talk of the "new value investor" or "value with a twist." In many cases, the fancy talk was just an excuse for a value fund to stray into the dotcom and high-tech arenas-areas that traditional value investors avoided.
The run of underperformance and the large gaps between growth and value in 1998 and 1999 took their toll, and by last year, some value funds were going the way of Montgomery Ward. As investors looked for quick profits in technology, slower-growing value funds were being abandoned. Value-investing icons lost their luster. Robert Sanborn, a staunch value investor who considered the risky technology sector off-limits, was ousted as manager of the Oakmark Fund in March because of poor fund performance and shareholder redemptions. Value specialist Skyline Asset Management, faced with a run of outflows, merged its three value funds into one late last year.
More and more value-fund managers seemed to delve into technology and Internet stocks, while finding ways to justify buying into companies that had no P/E ratios, because they had no earnings. "Stocks were rising to extraordinary levels based on metrics not used in my lifetime," says Rick White, co-manager of the Neuberger & Berman Guardian Fund. "Mouse clicks, unique visitors, houses passed and things like coffee consumed were being used in lieu of earnings ... and people were straightlining this into the future."
While the technology- and Internet-driven mania lasted, value looked at best boring and at worst a relic. But value managers who stuck to their principles are speaking in glowing terms about the future nowadays.
Even if the return to value is a backlash to the manic technology buying in 1999, Maramarco feels this could be the start of an up cycle for value. Unlike the spring of 1999, when a jump in value growth turned out to be a fluke, the current run has been sustained, he says.
"It's kind of hard to talk about a knee-jerk reaction when you look back at an eight- to nine-month period where value has come back into favor as much as it has," he says. His Babson fund finished 2000 up 9.07%, below it's 10-year average of 16.19% but a major improvement over 1999.
Maramarco says the fund's practice of researching companies "from the bottom up" paid off. "It's still a process that encompasses things like price-to-book value, cash flow and quality of earnings," he says.
Some of the Babson fund's successful holdings included Duke Energy and Boeing, two of the fund's core longtime holdings that also happened to have been poor performers the last few years. He also cites Allstate, trading at about $38 per share in early January, as an example of a successful buy that probably wouldn't have happened if the fund had bent to short-term pressures.
"I think the best thing I did this year was adding Allstate when it was below $20, back in March," he says. "Nobody on Wall Street had a buy on it. We knew it was a cyclical business ... and it was trading at book." Allstate was up nearly 60% in 2000.
Allstate also helped the Heartland Select Value Fund gain 30% last year. The fund also made a major play in health care, anticipating a loosening of government restrictions on reimbursements would boost hospitals and nursing homes at a time when health-care companies were streamlining. "We saw it as a double-whammy on the positive side," says fund co-manager William J. Nasgovitz.
In this mercurial market, growth stocks can morph into value stocks almost overnight. Among the stocks Heartland Value bought were the nation's two largest hospital chains, HCA-The Health-care Co. and Tenet Healthcare Corp. HCA was up more than 25% in 2000, and Tenet was up more than 40%.
Confident that technology has had its day as a growth industry, Heartland now has it under the microscope as a value play. In the spring, the fund bought Credence Systems, a maker of testing products for high-volume semiconductor manufacturers. The company nose-dived along with other stocks in the Nasdaq sell-off, falling from about $80 to $15. Heartland then saw it as a value pick "because it is one of the world's leaders in this business," Nasgovitz says. The stock had risen to $23 at year's end.
Some of that "old-fashioned" investing also paid dividends for the MFS Value Fund, which got a healthy boost from the financial sector in 2000, particularly insurance. The fund finished 2000 with a 29.4% gain.
The fund decided to add weight to its insurance holdings last year after seeing stabilization in personal-insurance line premiums after about a 10-year decline, Baldini says. The seminal moment in the fund's analysis of the insurance sector came in February, when fund analysts attended a national insurance convention and saw that attendance was down 50% from the year before.
Baldini recalls that rather than being alarmed at the low turnout, they used the low attendance as an opportunity. "There was no one there, and we got one-on-ones with every single company that was there," he says. One of the fund's buys, Hartford Financial Services Group, was up about 50% for 2000.
Another of the fund's winners last year, Boeing, also came about through basic research. The company, which finished the year up about 35%, had been hit hard by the Asian economic collapse in 1998 and was saying early in the year that orders were flat. With a little further digging, the fund found out that Boeing suppliers were reporting increased orders.
"This was just staying with fundamental research," says Baldini. "It's reinforcing the notion that when things are toughest, it pays to stick to what you do best."
During value's difficult times of 1998 and 1999, it was indeed tough to follow that advice. Traditionalist value investors struggled, and people such as hedge-fund manager Julian Robertson gave up in disgust and closed down Tiger Management, which was the largest hedge-fund group in the world. Then, there were the likes of Legg Mason Value's Bill Miller, who kept beating the market with a "new value" investing style that didn't mind having Amazon.com under its fold.
Value investors would say it couldn't last. Yet it did-at least until March 2000.
"They were sexy, they were hot and easy to tout," Arbor Capital's Vick says of the dotcom and technology stocks that fueled the market's growth in the late 1990s. "At the end, individual shareholders were buying them because they saw other people making money on them. Shame on the analysts, too, for not wanting to douse the party."
Playing around with S&P data, Baldini looked at the index's top performers based on one-year and five-year earnings projections. What he found in 1999 was that the best performers were companies with low short-term earnings projections and high long-term projections.
It amounted to a market on a quest for short-term profits, propelled by long-term hopes. "It depended on being able to have an inexhaustible source of capital to keep generating growth," he says.
The turnabout in 2000, Baldini says, was a transformation in which technology went from being viewed as a stable growth sector to one that is increasingly sensitive to economic conditions.
The sudden sour view on technology was largely behind the flight to value, says Keith Murray, senior associate at Moody's Investor Services. "When the Nasdaq had the big sell-off, it woke people up," he says. "You had a lot more people looking for something a little more conservative and steady."
There's an even simpler reason, observers say, why value may be ready for a good run of performance: It had to happen sooner or later. Historically speaking, growth and value have always bounced back and forth between being king of the hill and second fiddle.
"When you look over long periods of time, the market does tend to operate in cycles," says Scott Cooley, senior analyst at Morningstar. "It seems like value is due for a multiyear run ... Value stocks are still pretty cheap on a historical basis. I think they should fare pretty well."
There's another reason White has faith value isn't ready to die away: human nature. "People feel the pain of loss more than two times as acutely as they feel the pleasure of gain," he says.
So, to avoid pain, people are prone to dumping a stock at too cheap a price. It's a pattern of behavior that underlies much of the theory behind value investing, White maintains, and there's no reason to believe it will change.
One example, he said, was the Guardian Fund's decision to buy Bristol-Myers Squibb earlier last year when doubts about the FDA approval of a new blood-pressure drug sent the company spiraling from $65 a share to $50 a share in one day. As White stepped back and looked at what happened, he saw $38 billion knocked off the capitalization of a company over doubts about a drug that would account for maybe $2 billion in sales a year.
Fundamentally, the company was as sound as ever, and many still believed the new medication ultimately would gain approval. Guardian bought the stock, which rose to $69 a share at the end of the year.
It was the type of year, White says, in which funds that stuck to traditional value investing finally saw things click. "I think there are definitely people who absolutely stuck to their knitting," he says.