A Revival for Value?

06/26/2019 5:00 am EST


Richard Moroney

Editor, Dow Theory Forecasts

Has the time come to bet on a revival of value stocks? Value stocks have seldom suffered such a brutal losing streak as seen over the past five years. Value stocks have seldom been so cheap relative to all stocks or to expensive stocks, notes Richard Moroney, editor of Dow Theory Forecasts.

We think a lasting shift will likely require three things to happen: (1) Global economic growth accelerates; (2) interest rates begin to move higher; and (3) the migration out of actively managed equity funds into index funds slows. As of now, all three of these factors are still working against value stocks.

Now in its 25th year, the Focus List has recommended 290 stocks since its inception in December 1994' this list has delivered an annualized return of 8.8%, versus the S&P 500 Index’s 7.8% gain. Below, we review some of our favorite Focus List stocks for capital gains over the next 12 months.

Legal headaches at Alphabet (GOOGL) appear to have spread to the U.S., based on reports that the Justice Department is preparing an antitrust probe into the company. In the past couple years, the shares have repeatedly shrugged off big fines and new rules aimed at limiting the company’s monopolistic tendencies.

At 22 times trailing earnings, Alphabet’s stock trades at its lowest P/E ratio since 2014. Meanwhile, Alphabet presses further into cloud computing with the announcement that it will acquire data-analytics provider Looker for $2.6 billion in cash.

The global cloud computing industry is projected to grow sales 17% in both 2019 and 2020, says Gartner. Alphabet’s slice of the market was 8.5% last year, up from 6.4% in 2017, estimates Canalys.

CSX (CSX) shares have chugged 26% higher in 2019, overcoming the railroad industry’s challenging environment. U.S. railroads suffered 2% lower traffic in the first five months of 2019, with traffic falling more than 6% in the last two weeks of May. CSX has blamed the industry’s weakness on bad weather and uncertainty over tariffs.

But CSX has outgrown other U.S. railroads in the past year, helped by its pricing power and market-share gains. CSX has also improved its efficiency, using fewer railcars and reducing downtime at terminals — strategies that have helped its operating profit margin expand in four straight years. Encouragingly, CSX reported flat traffic for the March quarter. m.

Microsoft (MSFT) is one of the biggest benefactors of the growing demand for cloud services. Microsoft took a 16.8% slice of the global cloud market last year, up from 13.5% in 2017.

Its strong cloud position has helped the company string together 12 straight quarters of growth for per-share profits, 11 straight for revenue, and eight for operating cash flow.

Operating profit margins have risen steadily. Microsoft earns a Quadrix Value score of just 23, lower than any other Focus List stock. But Microsoft shares, up 29% for the year, trade roughly in line with other S&P 1500 Index systems-sofware stocks.

Property-and-casualty insurer Progressive (PGR) has been one of the top stocks on our current Focus List, rallying 21% since its August upgrade, while the S&P 500 Index edged 1% higher.

The stock still looks timely, scoring above 90 in Quadrix for Momentum, Earnings Estimates, and Performance. Yet the shares remain attractively valued, trading at 16 times trailing earnings, below their three-year average of 17 and industry median of 18.

Progressive boasts steady growth, with sales climbing in 33 straight quarters, while both per-share profits and operating cash fl ow are up in each of the past 10 quarters. Analyst estimates are rising for the June quarter, with the consensus now projecting 18% higher per-share profi ts on 14% revenue growth. Progressive is a Focus List Buy and a Long-Term Buy.

Thermo Fisher Scientific (TMO) enjoys a recession-resistant business model of supplying medical instruments and laboratory equipment. The shares have rallied 27% in 2019 yet trade at 25 times trailing earnings, roughly in line with its S&P 1500 sector median and below their own five-year norm of 29.

Citing confidence that it can keep taking market share, Thermo Fisher raised its long-term targets last month. Per-share profits are now projected to grow 13% to 15% annually through 2022, while organic sales should climb at an annual clip of 5% to 7%.

Management expects to spend $29 billion over the next three years, with 65% of that going toward bolt-on acquisitions and the remainder used for stock buybacks and dividends.

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