It’s been 18 months since Brian Frank bought a stock, the longest he’s gone in the 12 years since founding his firm specializing in beaten-down equities.
Why should he, with price-earnings ratios above historical averages and investors minting money with momentum strategies that call for nothing more than sticking with winners? The Frank Capital Partners LLC manager has found nothing to get excited about amid the third-longest bull market in U.S. history.
Lately, with U.S. shares heading for their third straight monthly retreat, Frank sees reasons for optimism, among them the selling that battered last year’s high-flyers such as Amazon.com Inc. and Netflix Inc. He’s hoping it represents a shift in markets that will return his style -- value investing -- to favor after three years in which every prediction for its success has proven premature.
“As a value guy, you’ve seen companies have lower profits for the last two years, but the market has been in a steady march up,” Frank said. “Clearly the market can go down, and it’s not rigged. That makes you feel sane.”
The past year has been anything but easy for value investors, who seek out stocks priced at deep discounts to earnings and assets. Managers have had to justify an investment style that lost to momentum by more than 50 percentage points in 2015, as megacap technology firms dominated while oil and mining companies plunged.
Turbulence in 2016 has spurred a handful of reversals that value managers say set the stage for success. Among them is the restoration of something known as dispersion, or the degree to which valuations in a group of stocks differ from one another. For the past three years, P/E ratios among S&P 500 companies have grown more and more alike, pushed together by a combination of Federal Reserve stimulus and index investing. Now the differences are starting to widen out again, a positive development for stock pickers.
One byproduct: the 10 cheapest stocks among the 50 largest in the S&P 500 currently cost less than 10 times earnings, the first time that’s been true since 2012.
“I don’t remember a period where you’ve gone this long without large-cap value stocks ever being solidly in favor,” said Phillip Titzer, who helps oversee about $1.4 billion as vice president of investment operations at Edgar Lomax Co., which invests in large-cap value stocks. “We’ve never wavered, but there have been pockets of time where people say, ‘Gosh, what are you guys doing wrong?’”
It’s not like bargains don’t exist. While energy company earnings volatility is distorting P/E ratios, the group traded this year at 1.3 times book value, or assets minus liabilities. That was the lowest since at least 2000. Financial companies in the S&P 500 reached 1.1 times book value this month, the cheapest in almost three years.
At the same time, the S&P 500 has a P/E ratio of 17.3, down 8.4 percent from 18.9 in July, according to Bloomberg data. The P/E would still have to fall another 4 percent to reach the 10- year average of 16.6.