Value Investing Outlook for the 2nd Half of the Year
So far, value stocks have underperformed in 2018 especially when compared to FANG stocks and other higher growth names in the market. This underperformance makes sense since most value stocks were either overvalued or priced for perfection entering the year. The good news for value investors is that underperformance in 2018 has made valuations more compelling versus their growth peers.
Does this mean that now is the time to jump in with both feet in the value space? Not quite. Many value stocks have declined in 2018 and some are trading at low valuations, but most are still not worth the risk. Financial stocks are trading at reasonable price to earnings ratios, and many healthcare stocks are also trading at reasonable valuations currently. Most of the time, stocks are cheap for a reason, which is why despite modest PE ratios in some value names we still don’t see a lot of upside.
Take financials for example – The PE’s are low double digits for most of the major banks now, but a look at the yield curve shows that it’s compressing, which is a negative. Bank stocks still have many moving parts to their earnings, which are hard to predict. Trading revenues may be weaker than expected, and reduced housing activity considering higher interest-rate could hurt as well. That being said, it may be worth it to add a small position in some banks, but we wouldn’t jump in with both feet at this time.
A similar situation exists in healthcare stocks. Valuations are reasonable, but the growth in the sector is relatively muted, making large gains in these stocks hard to come by. It’s mainly a game of dividend yield combined with stock buybacks making up most of the returns. The returns are not nonexistent, but we don’t see the upside in the shares meaningfully greater than the downside for most names in the sector.
Consumer shares are also in a similar situation in our view. Consumer discretionary shares have performed well this year and over the last one-year period. However, after the large gains in the sector, potential downside exceeds upside in most cases. Consumer staples are intriguing, as they have declined tremendously year to date. Some names are interesting, especially those like General Mills (NYSE: GIS) and Kellogg (NYSE: K) because they trade at mid double-digit PEs on calendar 2019 earnings estimates. In the long term, these can be good buys. Yet, with higher interest rates on the horizon along with higher commodity costs, there’s a risk that companies may miss earnings estimates going forward, making the investment case less compelling. It may be worth slowly starting to build a position in some consumer staples stocks, but we wouldn’t recommend them wholeheartedly yet.
Overtime we feel value stocks will make a comeback, either through their prices declining to more appealing levels, or the stocks just stagnating for a while until earnings can catch up to justify the risk of investing in them. We would certainly keep an eye on the sector and selectively add to opportunities if they present themselves.
Despite not finding too many compelling value stocks, we have found two stocks that are worth buying today: Royal Caribbean (NYSE: RCL) and Berkshire Hathaway (NYSE: BRKB)
All of the ideas expressed in this article are the opinions of Ideal Asset Management LLC
Before trading on any of the information in this article, consider consulting your financial advisor to make it suits your financial goals
Ideal Asset Management owns shares of BRKB and RCL for its clients
All investments carry the risk of loss