Portfolio managers at AllianceBernstein believe there is an opportunity in the US equity market because investors underestimate the earnings of value companies.
AllianceBernstein’s James MacGregor, CIO for US small and mid-cap value equities, and Cem Inal, CIO for US large-cap value equities said in a recent note that there is plenty of growth to be found in US value stocks.
“Investors eyeing the S&P 500 today might be anxious about valuations near all-time highs and returns driven by a handful of names—notably the Magnificent Seven,” they said.
“On the other hand, the rest of the equity market offers what we call “magnificent others.”
“Value seems to be a member of that club today, with its evolved company mix, solid growth potential and reasonable valuations. We think active investors who do the work can find plenty of growth in value.”
Although value has a long history of outperformance stretching back to the 1920s, it has underperformed for the most part of the last 15 years.
During this “painful stretch” of lagging performance for the investment style, the AllianceBernstein portfolio managers say that the composition of the value investing universe has since evolved.
There is growth in value
In the past, value stocks have generally mirrored the make-up of the US economy – which was historically manufacturing-led.
As the economy has transitioned to be more information and services led, the value indices have evolved alongside it.
“Today, value companies are often less about things like assets and price to book value,” the portfolio managers said.
“Increasingly, they’re more about things like free cash flow, which knowledge-based and customer-service businesses will produce—and which we believe the market is misvaluing.”
“So the nature of how portfolio managers and research analysts look at value itself has been evolving.”
While the current value investing approach still encourages exploiting investor tendency to overreact to short-term events, MacGregor and Inal say it has been focused more on “troubled companies in macro-sensitive industries”.
Indeed, despite being vulnerable to a slowing economy, banks, energy and retail stocks tend to be favoured by many value investors.
“Today, investors are underreacting to the cash earnings power of value companies,” MacGregor and Inal said.
“In fact, value firms’ earnings growth has been consistent with historical patterns, whereas investors are less willing to pay for these earnings today.”
“As a result, value investors can access industry leaders that are growing earnings and market share with high profitability and long runways at attractive valuations. Essentially, there’s growth in value.”
Opportunities in onshoring and energy
The portfolio managers highlighted two global themes in particular which they believe are creating opportunities: onshoring and energy.
“As firms seek to de-risk supply chains by bringing links back onshore, this massive effort requires investment across the spectrum,” they said.
“This includes areas such as logistics, warehouses and inventory-management systems as well as factories and roads—not to mention the technology to manage it all.”
“Many companies that provide the needed building blocks for these supply-chain links live in the value universe. We think investors who can dissect these building blocks can find opportunity.”
The same applies for energy, in their view. With the growing presence of data centres, in part to support AI, more power will be required from utilities.
“Whether by facilitating the creation of capacity to alleviate shortages of natural gas or enabling the building of new ports to accommodate shipping, many firms are working behind the scenes and positioned to benefit,” they explained.
“And as renewable energy sources continue to expand, more facilities must be built and power grids upgraded. A host of companies play a role in making this happen.”
