2019 Should Mark the Return of Value Stocks
It’s almost hard to believe, but we’re less than four months away from marking the 10-year anniversary of the trough of the Great Recession, at least for the stock market. Since hitting bottom in March 2009, both the iconic Dow Jones Industrial Average and broad-based S&P 500 more than quadrupled on their way to hitting all-time highs, with the tech-heavy Nasdaq Composite delivering a better-than-quintupling since its bottom.
Although you’ve probably done well if you’ve hung onto a diversified portfolio of stocks, there’s little denying that growth stocks have left value stocks in the dust over the past decade. The Federal Reserve held its federal funds target rate at a record low (0% to 0.25%) between December 2008 and December 2015, and interest rates have risen in a relatively orderly fashion since. That’s created a very borrower-friendly environment for businesses.
However, that could change in 2019.
Value stocks may soon leave growth stocks in the dust
In case you haven’t been paying close attention, the U.S. economy logged its strongest gross domestic product (GDP) growth in nearly four years during the second quarter. This soon was followed by the lowest unemployment rate in 49 years, as well as the strongest wage inflation in a decade. This probably sounds great, and it is to some extent.
But the thing is, the stock market is forward looking, and this news is almost too good to be true, at least based on what historical data tells us. Rarely does the unemployment rate dip below 4%for too long. Similarly, history suggests that strong wage inflation is dealt with by the Federal Reserve being more aggressive with interest-rate hikes.
If the Federal Reserve does break from its recent pattern of three lending-rate hikes in a year and chooses to get more aggressive in 2019, it could put a serious crimp in lending activity to corporations. In effect, it would stymie growth stocks’ easy access to capital, making them less desirable from an investing perspective.
Something else you may not realize is that, when you compare growth and value stocks side by side over the 90-year stretch between 1926 and 2016, value stocks generated the better return. A study released by Bank of America/Merrill Lynch found that, while growth stocks returned an average of 12.6% per year over this 90-year period, value stocks left growth stocks in the dust with an average annual return of 17%.
Thus, with the market looking like it may be reaching a top and a number of red flags suddenly cropping up, we may finally see value stocks emerge as the go-to investment in 2019.
These value stocks should be on your radar
If value stocks do regain their swagger in 2019, here are a couple that could be worth keeping a close eye on.
Just say the name “AT&T” (NYSE:T) to a growth investor and you can actually watch them fall asleep before your eyes. But what growth investors are overlooking is a boring, yet incredibly stout, business model that’s built to survive even the steepest economic contractions. With a subscription-based content model, AT&T has generated between $31.3 billion and $39.3 billion in operating cash flow in each of the past five years. That leaves more-than-enough free cash to pay out its superior 6% dividend yield, as well as invest in new technology.
Speaking of new tech, AT&T’s development of 5G networks is the next major long-term growth driver for the company. Though AT&T’s rollout will be selective to start, data-hungry consumers are liable to use this faster network as a means to upgrade their smartphones and other electronic devices.
And of course, we can’t forget AT&T’s recent acquisition of Time Warner and its prized assets: CNN, TNT, and TBS. These networks act as a bargaining chip with advertisers and should lead to better pricing power. They’re also a dangling carrot as AT&T looks to lure video subscribers away from its competitors. Sporting a forward price-to-earnings (P/E) ratio of 8, AT&T should be on your radar.
Yes, biotech stocks can be value stocks — and Celgene (NASDAQ:CELG) is a great example of that. Despite double-digit sales growth, Celgene is currently valued at less than seven times next year’s earnings and sports a price/earnings-to-growth ratio of just 0.4. For context, anything below 1 is generally considered to be “undervalued.”
Celgene has caught a bad rap in recent years because of slower-than-expected sales growth with anti-inflammatory medicine Otezla, as well as a new drug-filing snafu with experimental multiple sclerosis drug ozanimod. The company is reliant on multiple myeloma drug Revlimid for more than 60% of its revenue, and investors have been displeased with the company’s diversification beyond its top drug.
Yet, Wall Street continues to overlook Revlimid’s long runway, which has been protected by litigation settlements. It’s unlikely that generic forms of the medication would flood the market until February 2026, giving Celgene plenty of time to ride the coattails of its cash cow. Meanwhile, most of Celgene’s core products are benefiting from strong pricing power, higher usage, and label-expansion opportunities. To boot, ozanimod offers plenty of potential (likely $2 billion or more in sales) once it’s approved, which is expected to happen based on positive clinical data.
Make sure Celgene is on your radar because the market appears to be missing something.
Whirlpool (NYSE:WHR) continues to get little-to-no respect from Wall Street despite its nearly 4% dividend yield, average annual net income of $591 million over the past five years, and a forward P/E of just over 7. The knock against Whirlpool is its reliance on the U.S. consumer, while the trade war between the U.S. and China is escalating. The company has seen material costs (i.e., aluminum and steel) head notably higher, which has reduced consumer interest, slowed sales, and coerced the company to modestly lower its full-year forecast.
However, we’ve seen this play out with Whirlpool many times over. It’s a cyclical company and typically peaks well before the U.S. economy does and bottoms well before things are at their worst. Consumers have traditionally shown a willingness to accept price hikes within 12 to 18 months, so fears of a continued sales decline likely are overdone. Further, Whirlpool’s push into Asia in recent years should help somewhat offset weakness in the North American market.
You have to ask yourself at what point does a value stock become too cheap? Personally, I think we’re pretty much there for Whirlpool.