After several strong years, finding cheap stocks is tougher.

    If the last five years have been trying times for many investors, they have produced good times for value investors. That hardly means that the first five years of the new millennium represented a golden age for value.
    Instead, value investors' success has been mostly a matter of relative performance. Some leading value managers say privately they wish they were big enough as people not to derive a certain measure of satisfaction from the travails of their counterparts in the growth arena. And after the last five years of the previous millennium, when markets made value managers look a lot less swift than daytraders and chimpanzees (there was little difference), those who made it through the 1990s feel like tsunami survivors.
    Since the bubble burst in March 2000 value, has outperformed growth by 15% a year, according to several measures. But the degree of outperformance is more attributable to the sorry behavior of many growth stocks than any sizzling spike up in value. Ironically, the continuing punishment that many growth stocks have received has transformed some of the most famous, high-flying companies, like Pfizer, into value stocks, confirming all the old verities that value investors love to cite.
    A return to reality, a reversion to the mean, a restoration of reason, call it what you want. After five years of what some would call a bear market and others would term a sideways market, most serious investors are reaching the conclusion that most financial assets are fully and fairly priced.
    Take Robert Rodriguez, manager of FPA Capital Fund. In a narrative on his Web site, dubbed Slim Pickings, in late January, he detailed the rather depressing process he and his staff went through reviewing all 1,382 companies in the Russell Value index. Among possible candidates that met their criteria, they found 95 companies, seven of which they already owned. Upon further review, half of the remaining 88 were quickly eliminated.
    After shooting down another 35 concerns, they wrestled over a list of five companies. Rodriguez's associates came up with convincing reasons to avoid four of the five survivors. He then had his colleague, Steven Romick, review the list to see if they had missed something. Romick identified four companies but conceded that he wasn't enthusiastic about any of them.
    So Rodriguez went back and used another of his traditional screens to make sure he wasn't overlooking any companies. This set of criteria produced 70 candidates, or 25% of what it did one year ago, and the fewest number of companies since early 1998.
    Today, Rodriguez worries that investors are continually raising their forecasts to rationalize current prices. They may be correct, but he can't find "a sufficient margin of safety."
    Other value investors don't think the pickings are quite that slim. Cliff Asness, who manages institutional pension money and a hedge fund at AQR Capital in New York, says, "As we measure it, the spread between value and growth is not as narrow as others find. So, we think value is still OK."
    As stock price levels have climbed over the last decade, some value investors have shifted away from the classic deep value investing method of trying to find underpriced assets with a liquidation value that exceeds the stock price. More and more, they are looking for companies that can turn their businesses around and surprise investors on the upside.
    "The lines [between value and growth] have always been blurry," says Jim Averill, a portfolio manager at Wellington Management and manager of the Hartford Value Opportunities Fund. "Aluminum was a growth sector in the 1950s, color TVs were in the 1960s, energy was in the 1970s, and tech always comes and goes."
    But unlike growth stock followers, value investors remain hyperconscious of the price they pay, and many will look to sell as soon as a stock reaches a fair price. "We've owned homebuilders forever-until recently," Averill says. "We're no longer in them. Our feeling is when [their price] gets over two times book value, they are overpriced. There is overenthusiasm in housing right now."
    Another major difference between growth and value investors is that the former sees problems at a company as reasons to head for the exits while the latter views them as opportunities. New product pipeline problems and political issues have caused pharmaceutical stocks to fall out of favor in many growth portfolios, but Averill is finding compelling values in Pfizer and Wyeth.
    "We are enthusiastic about health care," he says. "Right now we own less HMOs and more pharmaceuticals, and that's purely price-driven."
    Despite the run-up in prices, Averill still has 8% of his fund's portfolio in energy stocks. Key holdings include Total, a large French oil company which he thinks has the "best prospects for growth," along with Marathon Oil, a big refiner, and Devon Energy.
    Fully 28% of Averill's portfolio is in financial services, although he's looking at sectors and companies that are relatively immune to rising interest rates. In recent decades, financial services companies' earnings  have become less sensitive to rising interest rates than their stocks have. Plus, credit card companies have the ability to raise rates, Averill notes. And one of his key holdings, Citigroup, gets between 30% and 40% of its earnings overseas, where rates may not rise.
    Looking beyond Wall Street's myopic time horizon is the driving methodology behind the Oppenheimer Value Fund and the entire value group at the fund complex. Chris Levy, head of the group, says that 86% of the performance differential among value stocks is explained by the earnings of the companies going forward.
    What he and his team focus on is the three-year earnings outlook for each company they examine. Why? "If you look at how the typical large-cap stock is followed on Wall Street, there are, on average, 23 analysts with one-year estimates, 20 with estimates for two years and six with three-year projections," Levy says. "So that's where the analytical sweet spot is. Three-year earnings power doesn't get much attention."
    That said, it often takes a turnaround or catalytic event to achieve the kind of result Levy seeks. A case in point is former holding Aetna. When Oppenheimer bought the HMO, it was losing members and selling at a very low price-to-earnings multiple to its peers.
    "They had created a negative customer selection bias where they were attracting a lot of sick people, to put it bluntly," he says. "We felt new management would develop a new pricing strategy that would address the negative selection problem. We also thought it could attract a better, healthier customer without hurting their pricing so they could raise their margins. They did."
    Robert Olstein, manager of the Olstein Financial Alert Fund, takes a strong value orientation but prefers to differentiate between value and momentum, not value and growth. A forensic accountant, Olstein analyzes companies' cash flow in painstaking detail and prefers not to speak to management, considering it to be a waste of time.
    "We care about what management is doing, not what they are saying," he explains. "Spending one night with a financial statement analyzing the numbers is worth more than spending two nights dining out with management. Financial information has improved dramatically, but most people don't pay attention to it."
    Since 1995, Olstein's fund has generated a return of 16.7% annually. Spotting turnarounds is one of his specialties. His biggest winners have included McDonalds, Tyco, Disney, Merrill Lynch and J.C. Penney, all of which fell out of favor in the last decade but staged strong comebacks.
    Currently, he holds the besieged investment bank, Morgan Stanley, which he purchased in the mid-$40-a-share range. "We think it's worth $60 to $65 a share," he says.
    Realizing that value could be tricky, he acknowledges. Morgan Stanley's embattled CEO, Philip Purcell, has a board that appears to be packed with cronies, and ousting him, as dissident shareholders are seeking, requires a vote of 75% of the board. "He's a very good politician," Olstein concedes.
    Another beaten-up area he likes is the newspaper sector, including Tribune Co., Knight Ridder and Journal Register. Newspapers are experiencing serious circulation problems-many have been caught printing thousands of extra copies daily to maintain ad rates and then carrying them to the dump-but Olstein says those problems are reflected in their stock prices.
    William Fries, managing director at Thornburg Investment Management, says that many value stocks have defied expectations and displayed staying power over the last five years. In contrast, some traditional growth companies have failed to produce either persistent or cyclical earnings growth.   
    "Go back to October 2002, and cyclical industrials and commodity companies were not participants in the recovery early on," he says. "I don't think anyone was expecting energy companies to do what they have. In the summer of 2002, Wall Street had assumed the energy cycle had peaked. Now it looks like their earnings will continue to grow fast."
    Fries is also looking at companies with pricing power or cost-cutting potential like Molson/Coor's, which was created through a merger last year and will be increasing efficiency, for example, when it shuts its Memphis, Tenn., brewery in early 2007. And one bank that may prove conventional wisdom wrong and profit from rising interest rates is Bank of New York.
    At the end of the day, Fries thinks value, and energy in particular, may have room left to run. "Energy is still not a big part of the S&P 500," he says, "and supply is not easy to produce."