Many have left value investing in the past, citing years of underperformance. But Goldman Sachs argues that a revival of the classic strategy endorsed by billionaire investors like Warren Buffett may be in order soon, especially as the Federal Reserve considers cutting rates again.
David Kostin, Goldman’s chief U.S. equity strategist, thinks value stocks are ready to come back into trend as the valuation gap between cheap and expensive stocks is the widest it has been in nine years. This gap has historically been a precursor to strong performances by value stocks in the past, according to Kostin.
“A wide distribution of price-to-earnings multiples has historically presaged strong value returns,” Kostin said in a note. “However, a rotation into value stocks would require a sustained improvement in investor economic growth expectations, potentially driven by global monetary policy easing.”
Technology and long periods of low interest rates may be to blame as the U.S. bull market continues its decade-long stretch that pushes value investing further into a niche. Modest GDP growth has caused value names to fall behind with Goldman’s long/short value factor falling 7% since the beginning of May, according to Kostin.
If the Fed eases its monetary policy, it could lead to a change in attitude towards value stocks. A Fed rate cut, which many are predicting could arrive as early as July, would boost expectations for growth.
“The two most recent episodes of value stock outperformance were during the ‘reflationary’ period of 2H 2016 and ahead of the passage of the corporate tax reform law during late 2017. Both of these periods were characterized by a surge in investor economic growth expectations,” Kostin said.
Here are some value companies that Goldman is keeping an eye on as value investing makes a comeback, per CNBC:
High Sharpe ratio
For optimistic investors who want to bet on value’s grand comeback, Goldman has screened for value stocks with “a quality overlay,” which could carry three times the return of the typical S&P 500 firm with similar volatility.
The so-called high Sharpe ratio basket, consisting of 50 S&P 500 stocks with the highest prospective Sharpe ratios, includes laggards and value tilts by construction, Goldman said. Sharpe ratio is a measure of a stock’s performance relative to its volatility. Goldman uses consensus price targets and options six-month implied volatility to measure Sharpe ratios.
The median stock in the basket has returned only 7% in 2019, underperforming the S&P 500′s 18% gain this year, and it trades at a 31% discount on forward P/E, according to Goldman.
The member stocks with the highest earnings-related upside to consensus target prices include Western Digital, Qualcomm, Halliburton, Marathon Petroleum, Salesforce and Facebook.
