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The "Prudent" Case for Value
05/15/2018 5:00 am EST
The S&P 500 enjoyed 15 straight months of positive returns following the 2016 Presidential Election, but market history shows that since 1926, that widely followed equity index has endured 413 months of red ink, versus 694 months that ended in the green, observes John Buckingham, value investor, money manager and editor of The Prudent Speculator.
Yet, despite all of the ups and downs, rallies and corrections, and Bull and Bear Markets, the S&P 500 has enjoyed a return over the past 92 years of 10.1% per annum, illustrating the rewards available to investors able to stick with stocks for the long term.
Of course, keeping the faith is easier said than done, especially in today’s sensationalistic media environment where breathless talking heads warn almost daily that doom is imminent.
Indeed, just this year, investors have had to contend with White House Drama, Rich Valuations, Volatility Spike, North Korea, Trade Wars, Increasing Inflation, Rising Treasury Yields, Fear of an Overheating Economy, Fear of the Next Recession and Fed Rate Hikes to name just a few of the headlines that have undoubtedly caused consternation.
To be sure, all of these issues remain outstanding, but that is nothing new as there are always disconcerting events that equities must overcome and the old adage that stocks often climb a wall of worry is hardly a myth.
It is very much steeped in historical fact, given that despite all of the headwinds, Value Stocks have posted annualized returns of 13.4% and Dividend Payers have gained 10.6%, dating back to 1927.
That does not mean that the rough sledding endured thus far in 2018 won’t continue as 5% setbacks happen more than twice a year on average, while 10% corrections have occurred every 11 months and 20% Bear Markets have taken place every 3.5 years.
Needless to say, we are braced for additional downside volatility, but we very much like the Vannevar Bush quotation, “Fear cannot be banished, but it can be calm and without panic; it can be mitigated by reason and evaluation.”
Happily, as there are plenty of historical numbers readily available to crunch, reason and evaluation is at our fingertips. For example, Value Stocks have performed well (annualized returns of at least 10% on average) concurrent with and subsequent to rising inflation, 10-Year Treasury and Federal Funds rates.
It’s the same story when looking at an actual inflation rate in the 2.0% to 3.0% range and an actual Treasury yield in the 2.75% to 3.5% range, as Value Stocks have gained more than 17% on average over the ensuing 12 months.
We also can’t forget that stocks are not simply vehicles for day traders to push up and down. Equities ultimately represent ownership in corporations that generally become more valuable as their earnings grow. And, bottom line comparisons have been sensational of late, with 79.8% of the S&P 500 members that have announced Q1 results thus far exceeding expectations.
More importantly, a rebounding global economy, solid U.S. GDP growth and the benefits of the Tax Cuts and Jobs Act have led to significant strength in forward earning estimates.
Despite worries by some about peak profits, Standard & Poor’s projects (as of April 30) bottom-up operating EPS for the S&P 500 of $158.09 for 2018 and $173.45 for 2019, up sharply from $124.51 in 2017. No doubt, earnings per share will also be bolstered by stock buybacks.
Although we retain our long-term enthusiasm for equities, especially as dividend payouts have continued to rise, we suspect that we may have to be a little more patient than usual this year. We can live with that as in the all-important P/E valuation calculation, the E has risen markedly for many a stock.
Meanwhile, our latest recommendations include General Motors (GM). The auto and truck maker turned in an impressive Q1, including record earnings in China and from GM Financial.
While the competition is always fierce in the auto industry, and there is definitely some increased input costs to battle, we continue to believe that GM is executing on its core business incredibly well despite ongoing macroeconomic volatility.
We still like its solid balance sheet ($21 billion in cash and marketable securities), cost controls initiative, ability to generate free cash flow and generous capital return programs. The stock now trades for 6 times NTM earnings projections and yields 4.1%.
Real estate investment trust Kimco Realty (KIM) has interests in 475 U.S. open-air shopping centers, comprising 81 million square feet of leasable space concentrated mostly in top major metropolitan markets and housing a diversified stable of tenants.
Shares have been on a roller coaster ride thus far in 2018 (down 20% YTD), but the stock did bounce back on the announcement of solid Q1 financial results.
We are positive on KIM’s continued progression of selling lower quality assets, mainly in the Midwest, and focusing on redevelopment and improving leasing volumes.
While the retail environment is still evolving, it may be stabilizing for strip shopping centers, given vacancies were less than anticipated. KIM currently yields a hefty 7.7%.
Verizon (VZ) stumbled out of the gate this year, but reclaimed some lost ground after the company reported Q1 2018 earnings per share of $1.17 (vs. $1.11 est.) on revenue of $31.8 billion (vs. $31.3 billion est.).
Verizon reported 260,000 wireless and 66,000 Fios Internet net subscriber additions. VZ also reported that it has realized $200 million of the $10 billion, four-year goal for cumulative cash savings.
We think that the tough competitive landscape concerns are largely priced in and that the just-announced Sprint/T-Mobile merger (which would create more pricing pressure) is unlikely to succeed due to regulatory concerns, and believe that Verizon can continue to leverage its vast network to remain competitive over the long term in the wireless market. VZ also boasts a forward P/E of 10.8 and a yield of 4.8%.